Tax Free Dividend Investing

Mar.10.13 | About: Nuveen Maryland (NMY)

Thanks to all the kind words and encouragement for my first Seeking Alpha article, I am publishing another one. Readers, I again want to remind you that I am an ordinary investor with NO special knowledge, expertise or training!

I have one other kind of investment with which I have been VERY pleased over the long haul. It is Nuveen Maryland Premium Income Municipal Fund (NYSE:NMY) a 100% tax free, state and local bond based, exchange traded, fund. (This type of exchange traded fund existed long before the ETFs that are currently being heavily advertised.) The PLUS is, of course, the tax free status. Over the last 6.5 years, this fund has consistently cranked out a dividend averaging around 4.75% depending on the per share price. Remember, that is 100% tax free = more like 6+% depending on your tax rate. There is NO LOAD, coming or going, other than the trading commissions.

In view of decreasing interest rates, I was somewhat concerned about maintenance of the high dividend rate over the next decade or so. I looked at the portfolio of NMY and mostly saw bonds in the 5+% range extending 3 to 33 years into the future. I feel that the dividend rate is secure well into the future. If and when inflation causes taxable interest rates to begin to approach 8%, I can rethink this investment. At present, this is not a concern.

As with any investment, IF you can time your purchases to coincide with share price drops, you can also realize considerable price appreciation. For example, in October 2008, I had $2,000 that I was able to place into NMY shares at $9.93 per share. At present, those shares are worth $3,000, not counting dividend reinvestment. 11.5% per year average appreciation IN ADDITION to the consistent dividends. That purchase was a matter of being "in the right place, at the right time."

There is one other plus of a psychological nature. Investing in a fund of this nature means you are (predominantly) investing in YOUR state. Depending on the fund and its portfolio, you may be investing in education, roads, bridges, hospitals, and other infrastructure projects that are being funded through bond sales. In short, you are investing in the future of where you live!

There are TWO and a half CONS, that I see:

1. somewhat limited liquidity** because of lower daily trading volume. You can always sell "at market price" but you will likely receive a much lower per share price than you would like. BUT, if you want to set your sell price limit, you may either be limited to a smaller quantity sold than you would like, need to wait a while, or sell in pieces over several days incurring additional commissions.

2. Depending on the economy in and the management of your state and local governments, the share prices can and DO fluctuate! Much more than you might expect. Over the past 6.5 years, from boom through the Recession to now, the per share price of my fund has ranged from approximately $10 to $16.50. As of February 2013, Maryland has "again" received a TRIPLE A rating from the three major rating agencies.

2.5 If your state defaults on its debts, you could lose everything. However, if this happens (this has come close in a couple of states over my lifetime, but not in Maryland, where I live), no investment in anything is likely to be of value! I believe that people who put their $ in diamonds and/or precious metals are deluding themselves. In a total financial collapse, fuel, food and medicines will be valuable and little else.

** a couple of years ago, I attended a "free" seminar by some local "financial advisor" hawking his bundling of small investors and buying tax free bonds. When I asked about liquidity, he danced without a real answer. When I PRESSED him, he finally admitted that the concept he was selling had virtually NO liquidity for some fixed period of time. Be VERY wary of liquidity limitations!

I am only familiar with the Nuveen brand of funds of this kind. They are available from a number of companies and sources. They may or may NOT be available in your state. N.B. the tax free status of each fund may vary somewhat from 100% to something less than that. Research the funds available in your state. Look at their portfolios and determine whether or not you believe they are adequate to provide a consistent dividend over the long term. Check out the tax free status but be aware that this status can change from year to year. Look at the daily trading volume of the shares. Is it adequate to support your potential liquidity needs?

Disclosure: I am long NMY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.