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How To Profit From Stripped Municipal Bonds

By Jason Markum

Investing in the stock market is one of the hardest things that most people will ever do in their life. Because of this, it seems like we’re always looking for better ways to make money investing. One of those better ways to make money is by investing in stripped municipals. In this article I’m going to discuss stripped municipal bonds, what they are, and how you can profit from them.

Stripped Munis are bonds that are particularly attractive for people who are in a high tax bracket and who also know exactly when they need their money. Most of the time they come in maturities with less than one year, all the way up to 30 years which gives you quite a bit will leeway when making investment decisions. This is quite unlike zero coupon municipals, which usually have much greater callable dates.

Stripped Munis are never callable which is also a huge benefit under the right circumstances. They don’t pay interest but instead are sold at a great discount to their face value. When the bonds finally become due, you are paid the bonds full face value; and the difference between the discount price that you originally paid and the face value at maturity is the profit you will make.

There is a significant risk involved in these types of bonds because unlike other bonds, there are not often large markets for them. That means generally speaking, that when you buy them you will usually have to hold them until maturity, and you won’t be able to sell them earlier in a secondary market, in most cases. This may not be such a big deal, especially if the maturities are not very far into the future.

But what the heck are these things? Yeah, I should have explained this earlier! Stripped Munis are sort of like legal pyramid schemes. Brokerage firms will buy up a bunch of regular municipal bonds, and instead of selling these bonds to their investors, they hold onto them and instead sell what we call stripped municipals at varying maturities (which they invent out of thin air). The brokerage firm then uses the payments of the original bonds as they come due to pay off the stripped bonds over time. Maybe calling them legal pyramid schemes isn’t quite correct, but you get the idea.

The reason why brokerage firms do this is so that they can basically convert the regular municipal bonds which have much longer maturities, into the stripped Munis that have shorter maturities and since they are able to stagger the original bond purchases they can be sure to have a steady stream of cash to pay off the stripped bonds when they need to.

So basically its a financially engineering vehicle that allows you to reap the benefits of long-term bonds at a shorter term. There are many different stripped municipals to choose from including ones backed by pre-funded bonds, ones backed by high quality triple-A general obligation bonds, and insured stripped municipals.

Stripped munis give you a lot of flexibility and a lot of options that regular municipal bonds can’t offer you. Because of this I like to recommend them to everyone who asks. But like all investment decisions, be sure to do your own research into these bonds before you make any final decision.

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