Strategies to Enhance Your Dividends with Municipal Bonds
Exploring Investment Opportunities for Dividend Growth
As the stock market continues its upward trend, you might find yourself considering various investment avenues such as bonds and real estate investment trusts (REITs) to manage risk while increasing dividend revenue.
This approach is not just advisable; it's a timely strategy worth exploring. In our previous discussion, we uncovered a straightforward method to diversify your portfolio while securing an impressive payout.
Utilizing Municipal Bonds for Tax Advantages
This brings us to one of my preferred income-generating assets: closed-end funds (CEFs), particularly those focused on municipal bonds. Municipal bonds, commonly referred to as 'munis,' are issued by state and local governments to support infrastructure projects. The alluring aspect? Their dividends are typically tax-free for most investors.
In this context, we'll analyze one overvalued muni-bond CEF poised for a drop and another that offers a 7.4% dividend while trading at a unique discount—approximately 10% below its perceived value.
Understanding Yield Differences and Tax Equivalence
The tax benefits associated with muni-bond CEFs can significantly alter your investment returns. For instance, while a particular muni-bond CEF may yield 8%, depending on your tax bracket, it could translate to an effective yield of up to 13% on a taxable-equivalent basis.
Even though we currently hold only one muni-bond CEF, the rationale is clear: when you observe the performance of benchmark index funds, high-yield bonds, and REITs, munis appear to lag in the first half of this year.
Performance Trends of Municipal Bonds
Despite their underwhelming performance, there’s a growing belief that municipal bonds will recover as investors, wary of a stock market correction, seek stable, high-yielding, and tax-advantaged alternatives. Over the past five years, the primary muni-bond index fund has seen little growth primarily due to the stock market's robust trajectory capturing investors' attention.
Historically, when the muni-bond market experiences stagnation, it's usually followed by a resurgence, particularly if broader market corrections occur.
Historical Resilience of Municipal Bonds
For example, from 2007 to 2009, munis lagged but surged during the subsequent market downturn, providing investors with an annualized return of 8.3% over two years, even as stock prices plummeted.
A Glimpse into Current Market Conditions
As we navigated through the first half of the year, it seemed the stock market might repeat the events of nearly 20 years ago. However, the recovery can be attributed to the resilience of the economy, which remains strong in light of current challenges. This consistency in economic growth is something we have emphasized throughout this year.
Nonetheless, the performance of municipal bonds remains a focal point, with some investors taking a more aggressive approach.
A Closer Look at California’s Leading Muni-Bond CEF
Take for instance the Invesco California Value Municipal Income Trust (NYSE: VCV). Throughout 2025, its valuation fluctuated from a significant discount to a near 5% premium, meaning investors are currently overpaying for this CEF.
Unfortunately, this premium does not correspond to growth in the fund’s net asset value (NAV), which raises concerns about potential risks.
Discrepancy Between Portfolio Value and Market Price
In 2025, VCV's total NAV returns have dipped over 6%, highlighting a concerning disparity between price performance and its underlying asset value. The current market price is buoyed by investor expectations rather than a fundamental increase in value—an indicator that prompts a recommendation to re-evaluate any holdings in VCV.
While VCV is managed effectively and California’s tax revenue trends have been positive, the timing for purchasing this fund is not ideal as it’s currently overpriced compared to its historical valuation.
Identifying Alternative Investments with Greater Value
If you’re contemplating options in the muni-bond space, consider the abrdn National Municipal Income Fund (NYSE: VFL), which boasts a 6.2% yield and is trading at a 10.3% discount to NAV. This scenario presents a rare opportunity given its diversified bond portfolio and the inherent stability associated with municipal bonds.
Such compelling offers are unlikely to last long, making it an excellent time to evaluate your interest in municipal bonds, especially if you're seeking stability and yield without overpaying.
As the market continues to adjust and recover, focusing on reasonably priced municipal bond CEFs like VFL could be a prudent move in hedging against potential market volatility.
Frequently Asked Questions
What are municipal bonds?
Municipal bonds are debt securities issued by state and local governments to fund public projects, with tax-free interest for most investors.
Why invest in closed-end funds?
Closed-end funds offer investors a diversified portfolio with the potential for attractive yields, often focusing on specific asset classes like municipal bonds.
What risks are associated with municipal bonds?
Municipal bonds can be impacted by interest rate changes, credit quality of the issuer, and regional economic factors, potentially affecting returns.
How do tax advantages influence investing in munis?
Tax advantages enhance the effective yield for muni-bond investors, making them attractive to those in higher tax brackets.
What should investors look for in muni-bond CEFs?
Investors should assess the CEF's NAV performance, yield compared to market price, and historical management effectiveness before purchasing.
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