Tax Free Yields 6.5% and Higher?

(Mention of fund names in this article is not a recommendation and is used solely to illustrate some mechanics of closed end bond fund investing.)

Many investors are familiar with open-end, tax-free mutual funds offered by the larger mutual fund companies. Fewer investors are familiar with closed-end funds, which trade as stocks on a listed exchange. Because these closed-end funds are now trading at discounts to their underlying assets (which open-end funds never do), the yields on closed end funds are particularly attractive.

For example, if a $100 bond paying 6% could be had at a discounted price of $90, then your yield is $6/$90 = 6.66%. However, an investor cannot just blindly purchase such funds. The discount might be because of an anticipated dividend cut (open-end funds also reduce their dividends, but this does not directly effect the share price). Or, some funds may be more risky because they use leverage.

For example, a fund will borrow money short term at 4% to buy long-term bonds at 6%. The fund earns a 2% profit for its shareholders on the borrowed funds. But what if the short-term rates jump to 6.5%? Then the fund is only earning 6% on the long term bonds owned, but is paying out 6.5%--a losing proposition.

Therefore, it takes some research or guidance by an advisor on choosing funds with high yields, discounts and lower risk levels. The following funds were mentioned in Kiplinger’s Personal Finance Magazine in December 1999. The information will not be current by the time you read this, so please check off the coupon for current information.

If you’d like to structure the income portion of your portfolio for higher returns, check off on the enclosed coupon for additional details.