What Are Tax Free Municipal Bonds?

Tax free municipal bonds are issued by towns, counties, school districts, or practically any other local government entity that needs to raise money to fund public improvements.  Just as a corporate bond is backed by the earning power of the issuing corporation, municipal bonds are backed by the taxing authority of the municipality issuing the bond.  While not common, it is possible for government entities to default on their debt.  Therefore, diversification is still an important consideration when investing in tax free municipal bonds.

Characteristics Of Tax Free Municipal Bonds

• No Federal Income Tax – The primary advantage of tax free municipal bonds, of course, is that you won’t owe federal income tax on the interest payments (there is one exception, which I’ll discuss below).
• No State Income Tax – If you buy tax free municipal bonds issued by your state of residence, you probably won’t owe any state income tax in addition to the federal income tax benefit.  There have been a few court cases challenging states’ ability to grant tax-free status to their own municipal bonds while taxing those of other states, but so far the rules have held up.
• Beware The Alternative Minimum Tax (AMT) – Many municipal bond fund invest in so-called Private Activity Bonds, which are bonds issued on behalf of a private user to finance some private project.  An example would be a bond issued by a city to help pay for a private real estate development or factory.  A city might choose to do this to attract some job-creating project that might otherwise be built somewhere else.  Interest on Private Activity Bonds are taxable under the AMT, although they are still tax-free under the regular tax code.  Tax-payers caught in the AMT trap should avoid municipal bond funds with significant private activity bond holdings.  Vanguard’s municipal bond funds intentionally limit AMT exposure, so that’s where I suggest you start.

Buying A Municipal Bond Mutual Fund

Buying a municipal bond fund is much like buying a taxable bond mutual fund.  Attributes to consider include average duration, average maturity, yield to maturity, and credit quality.  As always, lower-quality municipal bonds tend to pay higher rates;  however, they are also at higher risk of default.  For more on selecting a municipal bond fund, check out How To Choose A Bond Mutual Fund.

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Start A Roth IRA Cheap At T Rowe Price

Enter T Rowe Price (TROW),  which for the past several years has offered a program allowing you to start a Roth IRA with as little as $50 so long as you agree to participate in an automatic investment plan, contributing at least $50 per month to your new IRA.  Almost everybody can afford to invest $50 per month, so there’s really no excuse not to start saving for retirement right away.  While Vanguard is my favorite, T Rowe Price is a well-regarded fund company in its own right.  T Rowe Price’s fund expenses tend to be higher than their Vanguard counterparts, and T Rowe is known more for its actively-managed funds than its index funds.  Still, the ultra-low minimums more than make up for the higher expense ratios, especially since the difference in expenses amounts to literally pennies with balances that small.  Besides, you can always roll over your Roth IRA to Vanguard after your account has grown large enough.

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Why Eliminating Credit Card Debt Should Be A Priority

The rule of thumb is that if you can’t reasonably expect to earn a higher return on your money elsewhere, you should use excess cash to pay down your debt.  Why?  Because by carrying high-interest credit card debt you are making the bank rich, not yourself.  The average interest rate is currently around 15%.  That means for every $1000 you borrow on your credit card, you will pay $150 per year for the privilege.

To put that number into perspective, if you invested that same $150 per year in a retirement account and earned a long-term average of 8% per year, you would end up with over $20,200 in 30 years and over  $47,200 in 40 years.  That is an absolutely staggering amount of money when you think about it.  In a very real way, that $1000 purchase on your credit card isn’t just costing you $1000 plus the $150 interest payment, it’s costing you almost $50,000 over 40 years because not only do you lose the money paid to your credit card company as interest, you miss out on any potential interest those payments could have earned you.  Due to the miracle of compound interest, it doesn’t take long for the opportunity costs to dominate the equation.

The Basics Of Eliminating Credit Card Debt

Debt consolidation is big business, but completely unnecessary.  There’s absolutely nothing credit consolidation companies can do for you that you can’t do on your own.  Besides, do you think those consolidation companies are working for free?  I don’t think so.  Here’s all you need to know to eliminate your credit carrd debt as quickly as possible.

• Pay Off Your Highest-Interest Card First – Dave Ramsey teaches his students to pay off the card with the lowest balance first in order to give them a psychological boost at having accomplished a goal, however small.  Self-esteem is all fine and dandy, but the laws of mathematics state you should pay off the highest-interest card first.  You will end up paying less in total interest as a result and will eliminate your balances more quickly.  If you want to feel good about yourself, follow Ramsey’s advice.  If eliminating credit card debt as quickly as possible is your goal, pay down your highest-interest debt first.  Then pay down your second-highest-interest debt, etc.  Which will make you feel better in the long run, paying off that $50 sweater you bought on your Gap credit card or being completely debt free?
• Call And Ask For A Lower Rate – This is where the debt consolidation companies love to toot their own horn.  They justify their fees by saying they will negotiate with your credit card companies on your behalf to get your interest rate reduced.  Thing is, there’s absolutely no reason you can’t do this yourself, and you are at least as likely to get a rate reduction as the debt consolidation companies are.  Just call your lender up, explain that you really want to do the right thing and pay what you owe but you’re afraid you won’t be able to keep up with the minimum payments unless your interest rate is reduced. Most credit card companies will jump at the chance to help out a well-meaning customer.  Losing a points in interest is better than losing everything if you declare bankruptcy or simply decide not to pay.
• Ask For A Balance Reduction – Getting your balance reduced outright is much less likely than getting your interest rate reduced.  Still, it’s worth asking.  If you are truly in dire straights the credit card company might decide to take what they can get.
• Do A 0% Balance Transfer – This probably isn’t an option for many consumers these days without decent credit.  Still, it’s worth a shot checking out some 0% balance transfer cards.  Not having to pay any interest on a few thousand dollars will free up a lot of extra cash to put towards principal, or perhaps another high-interest balance you weren’t able to transfer.
• Do NOT Use Home Equity To Pay Off Credit Cards – Credit card debt is unsecured debt.  If you simply decide to stop paying, the worst they can do is ruin your credit.  Your Home Equity Line Of Credit (HELOC), on the other hand, is secured by the value of your home.  If you default on your HELOC payments, you could very well lose your home.  It’s not worth the risk.

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Why The Mortgage Interest Tax Deduction Is A Bad Idea

The mortgage tax deduction was ostensibly enacted by congress in order to make home-ownership more affordable for the average American.  Perhaps the deduction did serve that purpose originally.  The day the mortgage interest tax deduction went into affect, the purchasing power of those in the market for a new home increased significantly.  Let’s give congress the benefit of the doubt and assume sellers didn’t immediately catch on.   Thus, the first round of buyers got a great deal on a new home courtesy of good ol’ Uncle Sam.

For the average modern American family, the deduction might be worth perhaps $100 per month.  Sounds great, right?  Not so fast.  The real estate market has become increasingly sophisticated over the past few decades as the home-ownership rate has skyrocketed.  While the mortgage interest deduction might once have actually improved home affordability, those days are certainly long gone.  Today, the value of the mortgage interest tax deduction is priced in to the cost of real estate.  That is, the market has automatically adjusted itself over the years (as markets are wont to do) to cancel out the benefits of the popular deduction.  Since buyers tend to base what they think they can afford on monthly cash flow instead of total cost, the mortgage deduction tends to increase the amount buyers are willing to bid on a given property compared to what they would be willing to pay in the absence of a deduction.  In essence, the deduction actually increases the average price of residential real estate by the average value of the deduction, rendering it useless.

“So the mortgage interest deduction is useless,” you say.  “But at least it doesn’t hurt anything, right?”  Ah, but it does!  Millions of dollars per year are wasted on tax services to account in large part for these deductions, money that could be invested far more productively elsewhere.  It is impossible to estimate, of course, but I feel confident the economy as a whole has suffered indirectly as a result of this deduction.  Every dime spent adhering to the tax code is a dime that could have been invested in new jobs, better infrastructure, better education, and better health care.  Too bad Americans will never give it up.

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What Exactly Does “Full Time” Mean?

When you’re an hourly workers, the distinction is easy:  by law, 40 hours is considered full-time employment and your employer has to pay you overtime if you work more than 40 hours per week.  So while you may be asked or even required to work more than 40 hours per week, you at least get directly compensated for it.  Many people wouldn’t mind working an extra hour or two per day for time-and-a-half.

Full-time salaried employees, on the other hand, don’t have it so easy.  Being an “exempt” employee means you aren’t eligible for overtime pay (at least in the U.S.).  The prevailing theory is that salaried employees are paid to do a job and should work as many hours as necessary to get it done.  Many if not most Americans buy this garbage hook, line, and sinker.  They waste their youth in the office, neglecting their friends and family in pursuit of the almighty dollar.  The irony, of course, is that the more hours these workaholics work, the lower their hourly pay.  I have personally worked with highly-paid software engineers and managers who, by virtue of their 60 hour work weeks, probably get paid something like minimum wage.

The flaw in the above logic is obvious if you think about it:  just what is meant by “until the job is done?”  If your office is at all like 99.99999999% of the offices in this country, the “job” is never done.  There is an endless stream of work to do.  If you finish today’s task by lunch, it doesn’t mean you get to go home after lunch.  To the contrary, there will always be a brand-new task to get started on.  Does that mean you are ethically obligated to work 24 hours per day (remember, the “job” is never actually complete)?  Of course not.  And yet that’s exactly what you are saying when you say salaried employees should work as many hours as necessary to “get the job done.”  What employers really mean when they say this is that they want you to work more hours for the same amount of pay.  They call it “work ethic.”  I call it inefficient mediocrity.

Full Time Means 40 Hours.  Period.

As a professional, I have to work at a pace that is sustainable for me.  Sure, I could kill myself working 60 hour weeks for what amounts to minimum wage to get tons of work done, but what’s the point?  No job is worth my health, my sanity, or my social life.  And even were I inclined to work  that much overtime, I wouldn’t be able to maintain such a pace forever.  Eventually I’d have a breakdown, and that wouldn’t benefit anybody.

All this isn’t to say I’m completely against working overtime occasionally.  If there’s an important project that requires my attention, I’m asked nicely, and I’m rewarded for going the extra mile (be it via comp time, a raise, or at least a thank you) I am more than willing to work the occasional Saturday.  It’s when working late nights becomes expected by my employer that it becomes a problem.

Do Workaholics Get Promotions?

It’s often said you have to work hard to get ahead.  Those first to arrive in the morning and last to leave no doubt believe what they’re doing will get them a promotion, a raise, or at least a hefty bonus.  Unfortunately, I’ve never seen this actually happen in the real world.  I have certainly seen co-workers who believe their promotions were the result of working so much overtime, but everybody else in the office was perfectly aware these individuals would have been promoted even if they worked only 35 hours per week.  In the end, it’s how efficient you are with the time you do spend at work that counts, not the quantity of time.

Do you think working more than 40 hours is an effective way of getting a promotion?  How many hours do you typically work?

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The 2010 Roth IRA Conversion Loophole

All that is about to change, starting in 2010.  While the Roth IRA contribution limits will remain, the Roth IRA conversion income limits will disappear.  If you have a Traditional IRA, non-deductible IRA, or any other kind of IRA you will be free to convert to a Roth in just a few months. Here are a few things to keep in mind.

• Convert only if you can afford the tax hit – Converting any tax-deferred IRA (such as a traditional IRA) is a taxable event, meaning you will owe regular income tax on the amount you convert.  If you can’t afford to pay the taxes without dipping into your account’s balance, it’s best not to convert.
• Keep your tax situation in mind - Since a Roth IRA conversion increases your taxable income for the year, converting may boost your income enough to make you ineligible for certain unrelated tax credits or deductions.
• It might pay to delay converting – All else equal, it’s preferable to pay taxes later rather than sooner.  If you can manage it, why not delay converting until 2011 or later?  Or perhaps you are planning on attending graduate school in 2 years at which point you plan on quitting your job to study full-time.  Since your taxable income will be practically non-existent once you quit work, that would be a perfect time to initiate a Roth IRA conversion since your tax rate would be lower.

How High Earners Can Convert To A Roth IRA

The 2010 Roth IRA conversion loophole is basically a cheap trick to allow high earners to share in the tax advantages Roth IRA’s offer.  Sure, the income limits are still there, but starting next year there’s nothing to stop anybody from contributing to a non-deductible IRA and converting to a Roth at the end of every year.  Since there are no income limits for non-deductible IRA’s, there are effectively no longer income limits on Roth IRA’s.

One caveat to look out for when taking advantage of this loophole is that you must keep deductible and non-deductible IRA contributions separate.  If you make non-deductible contributions to an IRA you’ve previously made deductible IRA’s to, it muddies the waters and you could end up owing taxes on contributions you’ve already paid taxes on.

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Muchas gracias to Tom at Canadian Finance Blog for including my article Beware “No Cost Refinance” Loans in this week’s Carnival of Personal Finance #230.  Other great articles from this week’s edition:

Use Your Emergency To pay Off Your Debt by Gather Little By Little – I am taking the opposite strategy.  I could easily afford to pay off most of my mortgage in cash right now, but I’ve chosen to keep it in reserve instead.  Losing your job tends to make you more conservative.

Travel Hacking For Noobs by Man Vs Debt – Most people are under the mistaken assumption that traveling is expensive.  In actual fact, traveling is generally CHEAPER than staying home if you do it right (you have to pay rent at home, not so on the road).  Of course, couch surfing can get old, but it just goes to show how completely unnecessary what most people consider “necessities” are.  Baker shows you how to travel on the cheap.

Mas Links Muy Buenos

Extended Home Buyer Tax Credit May Not Benefit Existing Home Owners – by Free From Broke

Open Enrollment Health Insurance Options – by Cash Money Life

Interview Your Interviewer – by The Wisdom Journal. Job interviews are a two-way street. They need to impress you as much as you need to impress them.

2009 Roth IRA Contribution Limits by Four Pillars

Great Stocking Stuffer Idea – A Short Beginner Investing Book by ABCs Of Investing. It might not be as fun as a Playstation 3, but it will benefit your children far more in the long run.

You Tell Me: Overdraft Opt-In Rule” by Being Frugal. What do you think about the new overdraft fee opt-in rule?

Top Low-Cost Canadian DRIP Stocks Ranked by Yield, Dividend Growth and Discounts by Million Dollar Journey

$8000 First Time Homebuyer Tax Credit Extension: Take Advantage Of Incentives Through June 30th, 2010 by Bible Money Matters

Tips For First Time Credit Card Users by Studenomics

Open Enrollment Window for health Insurance Benefits by Military Finance Network

Scottrade Review – Online Discount Broker by Dough Roller. I personally prefer Tradeking, but Scottrade was the pioneer in the super-low-cost online discount brokerage industry.

How to Buy a Slow Cooker or Crock Pot by Squawkfox. I’ve been wanting to buy a crock pot for a while but being lazy, I’ve never gotten around to it. Squawkfox turned me onto the joys of soaking dried beans, though. Delicious, nutritious, and cheap.

Rules and Limits for the Traditional IRA by Good Financial Cents

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I Loathe Activating Credit Cards

I absolutely hate activating credit cards.  They have you call a 1-800 number to talk to a guy who hardly speaks any English whose paid to up-sell every product under the sun.  Take my two recent experiences:

Anonymous Credit Card Company #1 (henceforth known as Bank Of Derkistan)

I’m not a huge fan of the Bank of Derkistan.  Their online interface is sub-par and their customer service absolutely dreadful.  Still, their rewards cards are pretty decent, so I put up with them.  I call their 800 number to activate my card and am immediately connected to a man in India who speaks with a heavy, impossible-to-understand accent.  “No big deal,” I thought.  I’d only be on the phone a minute at the most to verify my identity and I’d move on with my life.

After a quick verification process, the Bank of Derkistan (hereafter referred to as Derkaman) proceeds to tell me about all the features of my credit card.  It’s slightly annoying (it was common sense stuff), but at least he seemed enthusiastic about it.  It seemed a bit weird that he was trying to sell the card’s features to an existing customer, but I let it slide.  After his spiel, I politely think him for the information and prepare to hang up, thinking the conversation was over.  Boy was I wrong.

Derkaman abruptly went into up-sell-overdrive.  He clearly had the script well-memorized from reciting in 13 billion times, because his mouth was running a mile a minute.  Problem was, since his English wasn’t all that great to begin with all I heard was “derka derka mohala mumbai jihad.”  I should have hung up at this point.  And to all you over-sensitive nerds out there who are going to write me with “actually, derka derka jihad is associated with the Middle East, not India blah blah blah I have no friends blah blah blah” shut up.  I know.  You’re missing the point.

At a loss from not having understood a single word he said, I muttered a non-decisive “um, okay.”  That was a mistake, since it only served to encourage him.  By the time he’d gotten through a few more derka derka’s I had deduced he was trying to sell me something, most likely a credit monitoring service (turns out, he was).  He seemed to catch on that I was lost and slowed down enough to explain to me that he was going to go ahead and sign me up for this great new credit monitoring service Bank of Derkistan offered that would protect my credit from nuclear holocaust while simultaneously curing cancer, AIDs, and the common cold.  “That’s amazing and all,” I replied, and meant it, “but I’m not really interested at this time.”  Hint, never say “at this time” to a salesman.  They take it as a personal challenge.

Derkaman pressed on, ridiculing my personal hygiene, education, skill at dungeons and dragons, anything to convince me to purchase the credit monitoring service.  After reiterating at least 18 times that I wasn’t interested (hanging up is not an option at this point…my reputation for awesomeness was at stake) I loudly screamed some German-sounding gibberish into the phone (which probably meant something decidedly non-awesome like “the furry bunnies eat carrot cake”), prompting shutting him up.  Then I took his sister on a date and made her pay the bill.

This story isn’t nearly as hilarious in writing as it seemed when it happened (and yes, it really did happen exactly as I described it).  Point is, just say no to the Donnie D-bag’s on the phone trying to sell you crap you don’t need.  You can get your credit report for free from annualcreditreport.com and your credit score directly from myFico.com for a fraction of the cost Derkaman was charging.

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Intentionally Clever Ticker Symbols

PowerShares Dynamic Food And Beverage ETF: PBJ – You’d think food and beverage manufacturers would generally be recession-proof, but PBJ hasn’t fared especially well the last few years.  I prefer peanut butter and banana, personally.

Van Eck Agribusiness ETF: MOO – According to the prospectus, the Van Eck Agribusiness ETF invests in companies that derive at least half their income from the agriculture business.  That leaves plenty of room for interpretation.  If McDonalds to started raising their own cows, would they qualify for inclusion in the MOO fund?

First Trust Global Wind Energy ETF: FAN – This one might not be such a bad buy.  Of all the forms of alternative energy out there, wind energy might be the most promising, at least from an investment perspective.

Claymore/MAC Global Solar Energy ETF: TAN – Seems like TAN should be reserved for a tanning salon franchising company, but whatever.

iShares S&P Conservative Allocation ETF: AOK – With only 25% of its assets in stocks, AOK would have served investors well during the recent market crash.  One thing’s for sure:  investors in this conservative all-in-one ETF should have nothing to worry about.

Unintentionally Funny Ticker Symbols

Claymore/Robb Report Global Luxury ETF: ROB – Freudian slip?  Could they be subconsciously saying that most luxury goods amount to highway robbery?  I think they might!

Potash Corporation Of Saskatchewan Inc.: POT – Everybody should buy some POT once per month.  With their monthly 401k contributions, of course.

I’m sure there are many other hilariously awesome ticker symbols I’ve missed.  Post them in the comments!

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Those searching the web for Roth IRA rates are asking the wrong question.  IRA stands for Individual Retirement Account.  A Roth IRA is nothing more than a type of account with certain distinctive and highly-advantageous tax characteristics (see Roth IRA rules):  it doesn’t represent any specific investment;  rather, it is a tax-advantaged account you can use to buy practically any investment you want including Certificates of Deposits (see How To Find A High Interest CD Online)

What “Roth IRA Rates” Really Means

I’m assuming that what one is really looking for when searching for “Roth IRA rates” is how to get the best return for the lowest risk.  The answer to this question depends entirely on each individual’s risk tolerance and time horizon.  For some, CD’s or short-term government bonds are appropriate due to their guaranteed rates.  For others, an aggressive portfolio of stocks might fit the ticket.  And for yet others, the answer may be real estate.  But for most, the optimal portfolio will include a mix of all these asset classes and more.

Since there is unfortunately no such thing as a Roth IRA rate and Roth IRA’s don’t “pay” anything in particular, you’ll have to educate yourself about the investing process in order to make an informed decision.  Don’t worry, investing is a lot easier than it sounds and there are plenty of free and inexpensive resources to help.  For starters, check out my article on basic portfolio theory and my own Roth IRA allocation to get an idea of what a reasonable allocation might look like.

Other great books for beginners:

• The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William Bernstein
• All About Asset Allocation by Richard Ferri (read my review)
• The Bogleheads’ Guide to Investing by Mel Lindauer, Taylor Larimore, and Michael LeBoeuf
• Oblivious Investing: Building Wealth by Ignoring the Noise by Mike Piper (read my review)

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