Time to ride the muni? Mortgage jitters bring another plus: rising municipal-bond yields

This update reflects the start of trading this week of a municipal-bond ETF from Barclays.

NEW YORK -- Last week I wrote about how the mortgage mess has bitten borrowers and lenders, and how that's helped certain fixed income investments. There's more good news. I was surprised to discover another opportunity in tax-exempt municipal bonds.

"Millionaire Zone" investors always have a keen eye trained on healthy, safe incomes, and tax savings. Municipal bonds have always been a strong play for both -- especially for those in higher tax brackets.

Here's a 15-minute tip on why now is a good time for munis and how to get started.

You've heard about how the credit crunch has raised mortgage interest rates on the so-called "jumbo" mortgages over $417,000 -- as much as a full percentage point.

How about this? The crisis has also hiked some effective municipal bond interest rates as much as 0.5 percentage point. Suppose you're in a 35% combined federal and state income-tax bracket -- that's almost a 0.77 percentage point increase in the effective rate you receive.

And why? Does anyone really think that municipal bonds -- that is, bonds for state and local governments, water districts, sewer districts and so forth -- are any more risky because some subprime home mortgage borrowers are taking it on the chin? I don't think so. Now seems like a great opportunity to take a ride.

The muni schedule

Adapted from Bloomberg Information Services, here's a yield chart for AAA-rated municipal bonds today and 6 months ago, with yields on equivalent taxable bonds.

So -- wow. If you're willing to go with a 20-year maturity and you're in a 35% combined federal/state bracket, you can earn a 7.4% yield equivalent. For the kind of risk we're talking about, that's pretty good -- it takes a medium-risk corporate bond to achieve those levels.

There is some interest-rate risk -- risk that rates could go higher, depreciating your bond's value in the short term (it will always pay back 100% when it matures). You can, of course, eliminate much of that risk by going with shorter maturities or "laddering" -- buying a sequence of bonds with varying maturities.

Three ways to invest

The muni-bond world is complex for the inexperienced investor, and it may take more than 15 minutes to get totally comfortable with the choices. Here are three places to start:

1. Buy direct. Especially if you have a lot to invest, there are lots of individual bonds out there. If you do it yourself, you'll save management fees, which could amount to 0.5% to as much as 1%. Broker sites are getting better for individual bonds. The Fidelity Investments Fixed Income Center is a favorite, but there are others.

2. Closed-end funds. This mysterious world offers several muni-bond choices. Some are general, some are state specific (designed to achieve state tax savings). With closed-end funds, it's important to measure the premium or discount versus net asset value -- and usually good to buy at a discount. One of the largest, the Black Rock Muni Bond Trust pays a 6.2% yield, but is currently selling at a 6% premium to asset value. Most individual state funds are paying between 5% and 6% with modest discounts. The Wall Street Journal "Closed End Funds" listing each Monday is a good place to start your research.

3. ETFs. Surprisingly, the first has just shown up this week -- Barclays iShares S&P National Municipal Bond Fund. In October, competitors will come with the expected launch of PowerShares Insured Municipal Bond and the PowerShares National Municipal Bond Portfolios begin to trade.

To get 7% on a stable investment with no tax worries -- that seems like a good idea. Like a 15-minute blue-light special, I'd look now before the light moves on to something else.

Peter Sander contributed to this article.