RETIREMENT MILLIONAIRE RESEARCH REPORT How to Collect Thousands in Tax-Free Income Stansberry & Associates 1217 Saint Paul Street Baltimore MD 21202 USA www.StansberryResearch.com 30351 Published by Stansberry & Associates Investment Research. Stansberry & Associates welcomes comments or suggestions at [email protected]. This address is for feedback only. For questions about your account or to speak with customer service, call 888-261-2693 (U.S.) or 410-895-7964 (international) Monday-Friday, 9 a.m.-5 p.m. Eastern time. Or e-mail [email protected]. Please note: The law prohibits us from giving personalized investment advice. © 2012 Stansberry & Associates Investment Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Stansberry & Associates, 1217 Saint Paul Street, Baltimore, MD 21202 or www.stansberryresearch.com. 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How to Collect Thousands in Tax-Free Income Dr. David Eifrig Jr., MD, MBA Our country is dying from within… The enterprise and moral fiber that led this nation to its historic pinnacle is being slowly choked out by a pervasive, relentless enemy… our government and the 22 million government workers. You may think I’m unfairly villanizing all government workers. I realize a small percentage of government employees who are useful and needed. (Perhaps some of the members of the military.) But the fact is most government employees are useless. They’re the real reason our country is on the path to economic implosion. I’m sure you’ve seen it firsthand like I have… While having to wait hours in line at the DMV…. Or standing at a courthouse window for 15 minutes while these lazy workers chat on the phone with their friends… Or trying to go to the Post Office, but finding it closed because these workers have locked the doors early so they can have an extra-long lunch break. The fact is, their lack of productivity, combined with the entitlements they think they are owed, is not sustainable any longer. According to The Wall Street Journal when you add up all 50 states, they have a combined debt load of more than $4 trillion because of ridiculous government employee entitlements. And that’s only the state governments… The federal government’s debt is $15 trillion… Thanks in large part to our bloated bureaucrats in Washington. As sickening as that is, according to USA Today, “Average federal salaries exceed average private-sector pay in 83% of comparable occupations.” In other words, most of the time… more than 80%... some lazy government worker is making more money than a hard-working American, who is actually contributing to the betterment of society. I don’t need to tell you one of the immediate consequences of supporting these drags on society is oppressive taxes. Anytime you flick on the TV to hear how President Obama wants to raise taxes to “spread the wealth around”… you can be certain to whom he plans on handing that wealth. It ain’t you… 1 And trust me, the current debate of whether to end the “Bush-era tax cuts” (as if the former president invented the radical notion of letting people keep their income)… that’s just a prelude to crippling tax regimes. Consider this: From 1940 to 1963 the highest tax rate in the U.S. was more than 80%... During WWII, the rate climbed to an astounding 94%. While I don’t expect rates to go that high in the future… You can see our government has no qualm confiscating virtually all of your income if it decides it can put it to better use than you. Given the colossal public debts our limitless borrowing has created… it’s no doubt taxes are likely to go up for most Americans over the next few years. I don’t know about you, but I plan to keep as much money as possible for my family, instead of having my hard-earned dollars going to support a bunch of incompetent and mostly unnecessary government workers. And one of the best – yet poorly understood – ways to do this is through a simple financial “loophole” I call the “Tax-Free Income Account.” The investment lets you legally collect taxfree income checks every single month, for the rest of your life… no matter how much income you make every year. Anyone can take advantage of this. I’m talking about municipal bonds. Let me explain how it works… Unusual Relationship in the Bond Market As you may know, municipal bonds represent promises from local and state governments to pay back money they borrow. In exchange for borrowing money, they pay the bondholder interest every six months plus the original money (the principal) back at maturity (which ranges from two to 30 years). The money generated from the bonds is used for infrastructure – like building highways and firehouses. Holders of the “munis” receive income exempt from federal income tax and, in many cases, state and local income taxes. In normal times, municipal bonds are priced as nearly risk-free investments. But these are not normal times. And fear has driven the yields to levels that don’t make sense. That is handing us an opportunity we need to take... Normally, municipal bond yields trade for less than the equivalent maturity U.S. Treasurys. Assume the likelihood of default on a bond is equivalent... if one bond pays tax-free income (munis), the rate it pays on the principal should be less than the taxable bond. If you were in a 50% income tax bracket, a U.S. government bond paying 7% would yield only 3.5% after tax. In contrast, your tax-exempt bond yielding 4% provides the equivalent of a taxed U.S. government bond that pays 8%. 2 Take a look at the chart (below) showing the yields of 20-year Treasury and municipal bonds. The average “spread” between Treasurys and munis has been around 75 basis points (0.75%) going back to 1953. That means munis have traded with 0.75% less interest-rate yield than the comparable maturity U.S. Treasury bond. 18 Moody's AAA 20-Year Muni Bond Yield 16 14 20-Year U.S. Treasury Yield 12 10 8 6 4 2 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Since 1950, municipals traded at a lower interest rate than Treasurys almost 90% of the time. But for the last couple years, the spread has inverted and sits now at negative 64 basis points (or -0.64%). People believe the risk of default to municipal bonds is much higher than it’s ever been – greater even than during the Korean War, Vietnam, the 1987 Crash, the S&L crisis, or the tech bubble of 2000... At extreme times, it’s critical to chart your strategy based on facts. And right now, the facts tell me... The States Aren’t Going to Default... In 2010, banking analyst Meredith Whitney was on 60 Minutes claiming the municipal bond market was facing “hundreds of billions of dollars” in defaults. When Whitney made her prediction, $30 billion exited municipal bond funds in just three months. The biggest muni bond fund is the Vanguard Intermediate-Term Tax-Exempt Fund (VWITX). Shortly after Whitney made her claims about massive defaults, VWITX plunged below $13 a share (from close to $14 a share). One idea circulating argues the overall municipal debt, around $3 trillion, is unimaginably large and far too great to ever pay off... or for the states and localities to even cover the interest payments. This simply isn’t so... First, many state and local governments have legal requirements to balance their budgets... 3 and that means facing the reality of their fiscal decisions. Sure, property taxes are down and may go lower. But municipalities generally don’t shirk their obligations. In many places, budgets will be cut before the governments default on their bonds. Local citizens will start taking on some of the ancillary responsibilities. That’s why Whitney is wrong. We’re already seeing this in places like San Diego, where private citizens have started caring for the parks and deal with trash. And of course, taxes will rise. That’s the easy answer for most governments… turn the screws some more on the productive members of society. More important, the key question surrounding default is whether the municipality can cover its interest payment, or “debt service.” Turns out the debt service makes up a small part of the average state budget. The ratings agency Fitch reports debt service is “less than 10% of the government’s budget.” While income and property taxes are half that percentage at the state and local levels. Hardly reasons to renege on municipal debt. Or look at it another way... Take the total muni debt of roughly $3 trillion and say the average cost of the interest is 3% a year. That means total interest cost is $90 billion a year. Compare this to the state tax collections of $715 billion in 2009. Worse case, if all the muni debt was to be “guaranteed by the state” as some people claim, we’re talking about less than 13% of the total revenue would be needed to pay the interest. From a legal standpoint, it’s hard for localities to go bankrupt, which can mean walking away from local citizens who live off the income of the bonds. The worst case in modern history is Orange County, California. It went bankrupt over derivative trading losses... But eventually, the county paid every dime it owed on the bonds. And there’s more evidence to lead us to think things are improving and “hundreds of billions in default” is hyperbole. But Meredith Whitney couldn’t have been more wrong about munis. In 2011, defaults totaled just $2.6 billion. That’s a hair less than the $2.8 billion defaults in 2010 and hardly the disaster industry “experts” were expecting. There’s no reason for investors to avoid municipal bonds right now... First, the ratings agency Fitch reports that interest payments on debts like muni bonds makes up less than 10% of those governments’ budgets. Income and property taxes are half that percentage at the state and local levels. So there’s little reason for the vast majority of municipalities to default. Second, after falling 1.7% in 2009, state personal income tax revenue rose in 2010 and 2011. And tax revenue has climbed for the past eight quarters. Revenues in the third quarter of 2011 totaled $292 billion. This is 4% more than the same time last year. More tax revenue means more secure interest payments and lower default risk. Over the 40-year period of 1970-2009, the default rate for investment-grade municipal bonds was only 0.06%, compared to 2.5% for investment-grade corporate bonds. Despite 4 recent negative media attention, this illustrates that munis remain a high-quality, low-default asset class. The economy is chugging along slowly. As it improves, states and localities will collect more revenue. And there are two great ways to take advantage of this opportunity…. Tax-Free Income Opportunity No. 1: Nuveen Premier Insured Municipal Bond Fund (NYSE: NIF) The Nuveen Premier Insured Municipal Bond Fund (NYSE: NIF) is an exchange-traded fund that holds a basket of municipal bonds. So that means we’re pooling our money with other investors and minimizing the risk from any one or two bad investments. And of course, since the fund is invested in munis, our risk is already low. As I previously mentioned, the default rate on municipal bonds is low. This is the sort of low-risk opportunity I look for. NIF invests about 90% of its assets in munis rated Baa/BBB or better. The turnover rate is a low 8%. We’ll expect to get monthly dividend checks, currently paying $0.0755 per share every month. This works out to an annual 5.7% distribution rate paid monthly. Right now, NIF is trading at a slight premium to the value of its individual holdings (net asset value, or “NAV”). But once is at a discount again, this is a great buy. And as always, keep a 25% trailing stop on both of these positions. Put no more than 5% of your investing capital into each. Again, put no more than 5% of your investing capital into it. Tax-Free Income Opportunity No. 2: Invesco Municipal Income Trust (NYSE: IIM) Invesco Insured Municipal Income Trust (NYSE: IIM) invests in tax-free fixedincome securities. It holds a diversified portfolio of A-rated (or higher) municipal securities. The interest and principal payments are also covered by insurance. Owning a fund that holds insured investment-grade paper means we can sleep well at night. In addition, this fund tends to buy and hold its securities to maturity – measured by a relatively stable 13% turnover rate. Generally, I avoid bond funds that have a high turnover rate (meaning they buy and sell quickly). It means they are trying to trade their way to good performance. I prefer the fund managers spend time selecting safe credits to put into the portfolio and hold them to maturity. That way, we get exposure to the asset category (muni bonds) and are less likely to get burned by people trading interest rate changes. 5 We’ll expect to get monthly dividend checks, currently paying $0.075 per share every month. This works out to an annual 5.31% distribution rate paid monthly. For people in the 35% tax bracket, this works out to an 8.2% taxable equivalent yield. We’ll also make money as spreads normalize over the next two to three years. That would give us capital gains and lock in our yields at today’s levels. Like any bond investment, if interest rates rise, we could lose money on our initial capital invested (“principal,” if we were buying individual bonds). But at higher rates, the fund managers can also invest at higher rates, boosting our returns longer term. However, IIM right now trades at a slight premium to NAV. Please wait until you can buy it at a discount to NAV, Retirement Millionaire 1217 St. Paul Street Baltimore, MD 21202 1-888-261-2693 6