Are there guidelines for deciding which muni bonds in a portfolio to sell? -- Ron Dunn

Ron,

It's going to depend on individual circumstances. It's hard to generalize about those, but with some help from a couple of brokers, I'll give it a shot.

There are three broad reasons people buy munis, says Greg Carr, manager of fixed-income portfolio services at

A.G. Edwards

in St. Louis: To preserve principal, to meet a specific cash-flow need (for a college tuition payment, say), or to get an income stream.

Those are distinct goals, and the portfolios designed to meet them are going to look different. A principal-preservation portfolio probably focuses on high-quality bonds with relatively short maturities. A cash-flow portfolio might have only zero-coupon bonds, which don't make interest payments but which are ideal for savers because they sell at a discount to face value. Finally, an income-stream portfolio might try to maximize income by buying either relatively long-maturity bonds or relatively low-quality ones.

Regardless of what kind of investor you are and what kind of bonds you hold, there are a few general principles that apply.

Tax considerations:

Selling a bond may produce a capital gain or loss. Nothing is necessarily wrong with either of those things; just don't let them come as a surprise to you. As the

March 24 and

March 31 "Fixed-Income Forums" explain in greater detail, this is particularly complicated when a bond was purchased at either a discount or a premium. You can't assume you'll have a capital gain just because you bought at a discount, or that you'll have a capital loss just because you bought at a premium. Know your adjusted cost basis before you sell.

Credit-quality considerations:

Bonds can get downgraded. If you've settled on a quality threshold and a bond's rating gets kicked below that threshold, you may want to sell.

Liquidity considerations:

Munis are much less liquid than stocks or Treasury bonds. All this means is that if you buy a muni, the price at which you could immediately sell it back is probably significantly lower. Depending on the issue and the lot size, the price at which you could immediately sell it back might be lower by a full point or more. This is because most muni issues are relatively small, and it's not always easy to find buyers for them. The wide so-called bid-offered spread (the bid is the price at which you could sell, the offered the price at which you bought) compensates the dealer for the risk entailed in holding the security until another buyer is found. All this means is that in a situation where you're selling because you need some cash pronto, you might favor selling a relatively liquid issue, where you're likely to get the best price execution. High-quality or short-maturity bonds are generally more liquid than low-quality or long-maturity ones. But even relatively low-grade munis, such as those issued by New York City, can have good liquidity if the issuer has loads of bonds outstanding. For indications of the prices at which muni bonds are changing hands, be sure to check the

Bond Market Association's

Web site.

The reasons investors might want to sell a muni are as varied as the reasons they buy them in the first place. But here, too, it's possible to make some generalizations.

If the portfolio exists to generate income, the investor might consider selling some bonds and buying new ones that generate more income -- particularly if interest rates are higher than when the bonds were purchased. In that case, the bonds probably have coupons that are smaller than the coupons available on new issues, and are therefore trading at a loss. By selling, an investor may be able to simultaneously book a tax loss and get a comparable bond that pays a higher interest rate. Just make sure you're not replacing a good bond with an inferior one.

Another reason to sell muni bonds is to obtain more call protection. Most muni bonds become callable 10 years after they are issued. If you have bonds that are approaching their call dates, you may want to exchange them for newer bonds that are further from their call dates. If interest rates are lower than when you assembled the portfolio, that may put the bonds at a higher risk of being called.

If the point is just to boot some bonds from your portfolio and not to replace them, again it depends on why you bought the bonds in the first place, says Bubba Bennett, director of fixed-income marketing at

Prudential Securities

. If you bought them for income, you'll want to keep the ones with the fattest coupons. If you bought them for principal preservation and liquidity, you'd keep the shortest-maturity, highest quality bonds.

Send your questions and comments to

fixed-incomeforum@thestreet.com, and please include your full name. Fixed-Income Forum appears each Friday.

TSC Fixed-Income Forum aims to provide general bond information. Under no circumstances does the information in this column represent a recommendation to buy or sell bonds, funds or other securities.