by Archie M. Richards, Jr., CFP^®
April 23, 2001

Hilda writes that she and her retired husband find it difficult to climb the stairs of their two-story house. They've bought another lot on which they've planned to build a ranch house. But a column of mine suggested that the state government could be asked whether a house can be gifted to the local fire department. The department would set it afire to test its techniques and equipment. The home's value could be taken as a charitable deduction, and a new house could be built on the site without demolition costs. Hilda asks whether she and her husband should follow my suggestion or stick to their original plan.

I don't know what's best for you, Hilda. But using your situation as an example, here's how anyone might solve a complex financial problem.

First, write down the facts and assumptions. As a start, meet with the local fire chief to obtain his opinion. He might know whom to talk with in the state government about authorizing a gift to the fire department.

Ask a CPA to confirm that the tax deduction may indeed be taken and to calculate how much tax would be saved. Talk with a demolition company about the cost of razing your current home. If your house is set afire, how much would it cost to place your personal property in storage and to live elsewhere while the new home is built? How much would each lot sell for, after costs? Be diligent in finding the answers to all such questions.

On one side of a piece of paper, write the reasons to adopt one alternative, and on the opposite side, write the reasons to adopt the other. Be sure to record your feelings. They're just as important as the money. Then, take your time to discuss what's best.

After all this, the decision should be obvious. But if the two sides still seem equal, flip a coin. Once the decision has been acted upon, do not play "if only" games. You did the best you could. Get on with your life.

When needed, seek professional advice. But don't assume you need a professional to walk you through the entire process. He may have less common sense than you do.

Tom acquires mutual funds that buy tax-free municipal bonds, the interest from which is free from federal tax. He asks whether he should acquire funds that hold long-term bonds or the ones holding intermediate-term bonds.

An intermediate bond is repaid in two-to-ten years. A long-term bond: ten-to-thirty years. Generally, the longer a bond's duration, the higher the interest payments per $1,000 of maturity value.

The prices of all bonds are affected by changes in interest rates. The longer the maturity, the greater the effect. If a bond comes due in just a few days, interest rate changes affect the price hardly at all, because the payment of the face value comes so soon. But if a bond comes due in thirty years, the payoff so far in the future is nearly irrelevant. The price therefore is greatly affected by current interest rates. As the rates go down, bond prices go up, and vice versa.

Most municipal bonds can be bought back (or "called") by the municipality ten years after the bond was issued. If interest rates have risen, the bond price falls, and you're stuck with a loser.

But if interest rates have fallen, the municipality sells another bond issue whose interest payments are lower than those of your bond. The municipality uses the money from the new bonds to buy back the old ones. This is dandy for the municipality, because it ends up paying less interest. But for you, the call is not so great, because the price of the call is usually only two percent higher than the maturity value. On the downside, long-term municipal bonds are allowed to fluctuate all they want, but on the upside, the fluctuation is limited.

Why invest in anything that can lose big but only win small? If you must buy municipal bonds, stick with the intermediates. When interest rates go down (which is what I think they'll do in the next ten years), stocks generally go up. Forget munis. Buy index funds of stocks. Throughout American history, there has never been a ten-year period when stocks didn't beat bonds and lose less.