CHASING YIELD IS one of the dumbest mistakes an investor can make. Sure, you want to grab a better return on your hard-earned cash, but those extra fractions of a percentage point come with added risk. Just ask anyone who bought auction-rate or mortgage-backed securities in the not-too-distant past. When it comes to fixed-income investing, the return of your principal is more important than the return on your principal.

Given the recent, uh, "unpleasantness" in the housing and credit markets, it's understandable that investors would run screaming in holy terror from any bond having anything to do with single-family mortgages. That might well be a mistake. A recent change in federal tax law has removed the specter of the IRS's alternative minimum tax from single-family municipal revenue bonds. Sporting yields appreciably higher than comparable-term Treasurys, yet carrying microscopic risk, these bonds should start garnering a lot more attention from retail investors.

Every year state and local housing authorities issue $20 billion of these bonds to finance single-family mortgages. We know: Anything mortgage-related sounds like a sucker's bet, but these are overwhelmingly non-subprime, fully documented 30-year loans. And as bad as Moody's and S&P might have blown their calls on all that crazy securitized debt that hosed the housing and credit markets, historically, municipal bonds are rock solid. The odds of default on a top-rated muni are less than 0.01%.

The problem was that "tax-free" municipal bonds weren't nearly so attractive when they were subject to the AMT. That's why a provision in the housing bill signed by President Bush at the end of July is welcome news. It freed these housing bonds from that confusing and onerous tax.

"Individual investors have generally ignored these issues because interest was previously subject to the alternative minimum tax," Citigroup analysts wrote last week. "We expect that many individual investors will now include these bonds in their portfolios."

Maximum yields on the longest-maturity bonds around 30 years top 5.5%. Issues with maturities of 15 to 16 years can yield as much as 5%. By comparison, 30-year Treasurys currently yield about 4.5%. (These housing bonds carry that extra yield primarily because of prepayment risk, a big concern for institutional investors but much less so for individuals.)

We ran a quick search on E-Trade and found a good selection of top-rated AMT-exempt issues paying tempting yields at various maturities. (See chart below.) Costs will vary by broker, but E-Trade, for example, charges $1 per bond, with a $10 minimum and a $250 maximum transaction fee. If you're looking to put a lot of cash to work, then you'll come out ahead fee-wise by purchasing large lots.

With short-term interest rates trudging along at 2% it's hard enough to find low-risk, inflation-beating returns. Don't let the mortgage part scare you off. These bonds might deserve a home in your fixed-income portfolio.

Hello, Mr. Bond

Examples of High-Yielding Non-AMT Housing Bonds*
Issuer	Yield (%)	Date of Maturity
Wyoming Community Development Authority	5.57	12/1/2038
Missouri State Housing Development Commission	5.24	9/1/2030
Maine State Housing Authority	5.19	11/15/2028
Mississippi Home Corp.	5.13	12/1/2033
New York State Mortgage Agency	4.00	10/1/2017

* Tax/AMT-Exempt, Moody's and/or S&P top-two-tier rated or better

Source: E-Trade

Also See:
Best and Worst Taxable Bond Index Funds
Payout Funds Offer No Guarantees for Retirees
Best Money-Market Mutual Funds