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Q

I have recently invested in municipal bonds through your firm and a Vanguard long-term, investment-grade bond fund. My goal is to achieve distributions of at least 5%, as I plan to retire at the end of this year. My concern is that the value of the investments will go down once the economy recovers. What is the outlook for interest rates to increase and bond values to retreat?

A

James A. Klotz responds:

We are not aware of anyone who has been able to successfully predict the direction of interest rates for any reasonable period of time.

Long-term municipal bonds are purchased for the tax-free income they provide, with the understanding that market values will fluctuate. Most bond investors employ a buy-and-hold strategy and rarely sell their securities, making the value of their holdings irrelevant. A good example of this was evidenced a year ago when the Wall Street meltdown precipitated a dramatic decline in the value of all tax-free bonds. Today, most bond prices have completely recovered from that swoon.

Although the current economic environment of no or slow growth, high unemployment and low inflation are not traditionally the ingredients that produce higher interest rates, there are no guarantees. The only thing we can predict with any certainty is that over the long haul, interest rates will rise and fall.

For these reasons, we continue to recommend only investing funds that are available for the long-term and maximizing your income on every purchase.

This additional income, not available on short-term bonds, will enable you to ride out interest-rate fluctuations, which are inherent in every business cycle.