Dear Shareholder:
As the Federal Reserve Board raises short term interest rates and bond prices decline there is one thing as predictable as knowing the sun will rise tomorrow, and that is; one day the process will reverse; rates will decline and bond prices will rise, and it won’t be too awfully long either.
The most natural thing in the world is to begin to lose your nerve and imagine that prices may drop until there is nothing left. Actually, the price of our Kentucky Tax-Free Income Series fluctuates over a very narrow range by comparison with stock funds and other more volatile investments. Here is a look at its price over the ten year span from Jan 1, 1995 to Dec. 31, 2004. (Other Income series of different states would have a similar result.)
In January of 1995 and again in May of 2000 the share price was as low as $7.15. In September 1998 the price was $7.76. In May 2003 and February 2004 the price was around $7.80. The average price over the ten years is $7.50. You can see that historically you do not make money in a bond fund by trading on the price. The price fluctuates about 4% to 5% around an average price in this specific ten year period. So “how do you make money in a bond fund”? You make it on the tax-free interest you earn annually. If you had held the fund and reinvested the dividend for the ten years illustrated here, you would have had a total return of 5.95% per year, most of it completely tax-free. For a taxpayer in the 35% bracket, this is the taxable equivalent of about 9.50%.
If you lose your nerve and sell you will probably do so at the low side of the price cycle and park the money in a low interest, fully taxable money market fund. Even if you get back in the fund at the same price (almost nobody does) you have lost the current tax-free interest for the period you were on the sidelines. We have shareholders who have had this unpleasant experience. Someone has said; “Good judgment comes from experience, and experience comes from poor judgment”. Take it from me; you can’t trade in and out of a bond fund and make money; that’s poor judgment. But if you buy and hold a bond fund, you have excellent odds of making a total return that matches the dividend.
What do I think the price will do in the next twelve months? When that question is asked the first thing to say is “I don’t know”. I am not clairvoyant. The price can do anything within or even outside the limits of that chart. My best guess is that it will fluctuate within the range of, say, $7.30 on the low side to $7.75 on the high side. What seems to me to be limiting a larger price decline is the shaky stock market. You may have noticed that when bond prices decline the stock market tends to get sick, which leads to stronger bond prices.
Meanwhile, the threat of a terrorist attack subdues the possibility of an overextended stock market and makes bonds look like a safe haven.
Sea Stories and Shareholders: Having shared some of my experiences during the Korean War I am honored to report I have received personal letters from an Alabama and a Tennessee shareholder, both veterans of World War II. These shareholders, both members of Tom Brokaw’s “Greatest Generation”, had experiences that made mine look like playing paddycake. The shareholder from Alabama went aboard the battleship New Jersey as a new Ensign in 1944 and was aboard when that ship took a Kamikaze off Okinawa. Fortunately, a 1000 lb. bomb that airplane was carrying did not detonate.
The Tennessee shareholder was a Chief Petty Officer aboard the submarine Billfish, operating in the western Pacific. He survived many attacks by enemy destroyers, one episode lasting over 27 hours during which the Billfish hovered at nearly its maximum operating depth, badly damaged with heavy leaking from valves in the after engine room.
I can’t tell you how much I enjoyed receiving these letters. If there are others out there who are veterans of the WWII generation it would be great to hear from you.
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