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Combining Stocks And Municipal Bonds

- Alan Lavine and Gail Liberman



Aha! Is this mutual fund a better mouse trap?

Federated Investor's "Federated Muni and Stock Advantage Fund" gained more than 8 percent last year. Not bad, considering it invested in stocks and municipal bonds.

Now the investment company is promoting the fund. Why? It wants you to buy a fund that lowers the income tax bite. Typically, you pay only a 15 percent tax on stock dividends--profits companies pass on to shareholders. Plus, the municipal bond income is tax-free.

The fund will always invest a greater percentage of its assets in municipal bonds for tax-free income. Stock holdings should give the fund some growth. That's not a bad idea. But if you are in a high tax bracket, why not own a stock fund and a tax-free bond fund or individual tax-free bonds.

The advantage of this fund: You get professional management. The manager can change the mix of investments as financial conditions change. Currently, the fund is 58 percent invested in investment grade-rated municipal bonds. The rest is in dividend-paying stocks, like Citigroup, Bank of New York, General Electric and Loews Corp.

Because the fund owns municipal bonds and dividend- paying stocks, it is less risky than a fund that has 100 percent of its holdings in dividend-paying stocks. Yet, the yield should be slightly higher than it would be on municipal bonds exclusively.

Drawbacks to investing in this fund:

  • You might find better-performing stock funds and municipal bond funds in mutual fund land.
  • The fund must be purchased through a broker. So you either pay a front-end commission of 5.5 percent, an ongoing 1 percent annual fee or a back-end exit fee. Paying a broker is worth it if he or she helps you stay diversified and find good investments. Nevertheless, you can invest in a no-load mutual fund, which charges commission, from discount brokers.
High tax-bracket investors often do better to buy insured or AAA-rated individual municipal bonds. This gives them more control over their income taxes. You can offset gains in some assets by losses in others. Or, you might engage in bond swaps by selling a municipal bond at a loss, and writing it off on income taxes while buying a similar bond with the proceeds.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).


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