Seeking Tax-Free Income From Closed-End Funds

by Michael Walters and John Deysher

Seeking Tax Free Income From Closed End Funds Splash image

Four years ago we wrote an article for the AAII Journal highlighting the potential opportunities available in closed-end funds (“Rodney Dangerfield Investing: Closed-End Opportunities,” April 2007).

We think now is a good time to revisit the topic, with a focus on municipal bond closed-end funds (CEFs) and their newer cousins, municipal bond exchange-traded fund

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Michael Walters is an analyst with the Pinnacle Value Fund, a diversified, SEC-registered mutual fund specializing in the securities of small- and micro-cap companies. He is a candidate for the Chartered Financial Analyst designation, and he lives and works in New York City.
John Deysher is president and portfolio manager of the Pinnacle Value Fund, a diversified, SEC-registered mutual fund specializing in the securities of small and micro-cap firms. He is a CFA charterholder and has managed equity portfolios for over 25 years. He lives and works in New York City and may be reached at deysher@pinnaclevaluefund.com.


Discussion

Joseph from Washington posted over 2 years ago:

I have owned several tax free closed end bond funds all of which are currently below purchase price ranging from 5% to 20%. Although the income averages around 6%, they do fluctuate rapidly at times. I'm concerned that rising interest rates which appear inevitable may cause further declines in NAV.

I have been slowly consolidating these holdings as they ecompass approximaely 65% of our total assets.


Mark from New York posted over 2 years ago:

Closed end funds can be an excellent income producing vehicle, but you should always take the time to perform your due diligence....remember you are never married to any fund.


Tyler from California posted over 2 years ago:

Thanks for the article; I had not heard of the leverage in closed end funds having the effect of lengthening the bond duration. It makes sense and will help me next time I look at closed end funds.

It would have been helpful to include some explanation of how the AMT relates to muni income--with some funds being AMT free.


Michael from California posted over 2 years ago:

I would also like to hear about which ETFs and CEFs avoid AMT.


Charles from District of Columbia posted over 2 years ago:

How do you calculate the change in duration due to leverage?


Joseph from Kansas posted over 2 years ago:

Why would anyone want to purchase muni bonds through a fund?


Bob from Maine posted 10 months ago:

Thanks for an informative article. Been into single state (my own) individual bonds with great success until they started getting called the last couple of years. I find it difficult to find munis with no call provisions. I may just have to go national.


Sridhar from California posted 10 months ago:

I purchased MUE recently and already down by 5%. Should I buy more to average it should I cut loss and exit? Tomorrow is FOMC meeting and not sure of short term and long term impact on MUE.

Please advice. Thanks.


DAVE from Washington posted 10 months ago:

With the uncertainty of the fiscal policy under the Obama Administration Municipal bonds are likely to eventually loose their tax free status. The great society as proposed by Obama need a greater and greater source of income. All tax free binds are fair game. Remember this is a president who pledged NO NEW TAXES. We are no seeing a subtle 17% raise in every persons' taxes.


Charles Rotblut from Illinois posted 9 months ago:

Hi Sridhar,

We cannot give out personalized investment advice.

All bond funds are susceptible to downward moves over the short-term when interest rates rise. But, the timing and magnitude of interest rate changes is unknown and bond funds will experience different return characteristics than stocks over the long-term, giving you diversification benefits.

-Charles


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