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Keeping muni investments safe

By Jennie L. Phipps · Bankrate.com
Sunday, April 17, 2011
Posted: 10 am ET

Investments that keep a retirement nest egg safe are tough to find these days. Even municipal bonds, which have been the bedrock of many people's portfolio for years, are looking shaky these days.

I wrote this week about the threat that governments won't be able to cover their deficits or meet their pension obligations. This problem not only affects public employees, it also could have an impact on people who have invested in the individual municipal bonds of the public entities facing default.

Jonathan Bergman, vice president of Palisades Hudson Financial Group in Scarsdale, N.Y., offers these protection strategies if your retirement planning could be jolted by muni meltdown:

  • Sell your individual municipal bonds and reinvest the proceeds in a multistate muni bond fund. "Investing in a national municipal bond fund will reduce the risk posed by a single state defaulting," he says. "It's worth paying a bit more in state income tax for that protection."
  • If you're really worried about a single state's financial status, but are unwilling to sell its bonds, consider short-selling a single-state muni bond ETF. Bergman warns that shorting is tricky because it provides unlimited downside if the security keeps going up, but limited upside. In addition, shorting an ETF of an individual state will expose an investor not only to the state's financial strength or weakness, but also to price changes due to fluctuations in overall interest rates and the bond market in general.
  • The best way to hedge against a state default is to purchase credit default swaps, which serve as insurance for bond holders. If a state misses an interest or principal payment, bond holders with swaps are made whole. You have to be rich to play this game because credit default swaps are usually sold in amounts that protect a minimum of a $10 million investment.
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