Now's the Time to Embrace Municipal Bonds

Munis are especially good for constructing ladders, because, for now, they're paying more than taxable Treasuries. In a ladder, bonds come due serially over several years. If you don't need the money on a bond's due date, you can reinvest. Planner Jonathan Krasney of Krasney Financial in Mendham, N.J., is currently using five-year ladders of actively traded munis rated A or BAA by Moody's. The lower credit quality isn't a problem, he said, because of the short maturities.

There are other ways of indulging in munis that you might consider:

· Exchange-traded funds -- the largest being iShares S&P National Municipal Bond Fund. They're not a best buy. You pay 0.25 percent in expenses plus brokerage commissions, compared with 0.15 percent for Vanguard's Intermediate-Term Tax-Exempt Fund with no commissions. Vanguard's fund is down just 0.49 percent for the year, compared with 2.58 percent for National Municipal Bond Fund.

· Closed-end muni funds -- avoid them, for now, said Cecilia Gondor, executive vice president of the closed-end research firm, Thomas J. Herzfeld Advisors in Miami. They're best bought at large discounts from the net-asset value of the securities they hold. The last big buying opportunity came on Oct. 10, during the market panic, when average discounts reached 26 percent. Since then, discounts have narrowed to 12.7 percent. Gondor expects some issues to exceed 20 percent again, during year-end tax selling and after some of the funds announce dividend cuts.

· Pre-refunded municipals -- for absolute safety from default. These bonds were issued years ago at higher rates. When interest rates fell, in the early years of this decade, municipalities issued new bonds, used the proceeds to buy Treasuries, and escrowed the Treasuries to support the older bonds. The escrow account pays the interest and the principal on the bonds when they come due, usually at their first call date.

It's like buying tax-free Treasuries, Cohen said. They generally, but not always, pay slightly less than a comparable general-obligation bond.

Two years ago, fixed-income investors forgot that risk was in the world, said Morningstar's senior mutual fund analyst, Lawrence Jones. They're remembering now.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis contributed to this column.