My wife and I had accumulated a very nice portfolio of nine Virginia munis. Three have been called. The remaining six pay from 5.75% to 8.1%. We would like to replace individual bonds as they mature or are called, but with what? I can't find an individual Virginia muni paying much more than 5%. T. Rowe Price's short-term Virginia muni fund yields about 3.5%. Its long-term Virginia fund yields about 4.6%. I can get 3.5% in my Fidelity tax-exempt money-market fund. The extra 1% in the long-term fund is not worth the wild swings in NAV that go with it. And if I don't catch the upturn in interest rates exactly right, I will lose a lot of principal value. The strategy for us -- retired and in our 60s -- should be to make enough profit from equities each year so that, reinvested in bonds, our purchasing power increases. With an unpredictable stock market and low interest rates, that strategy just doesn't work. Am I missing something? -- Mike Hugo

Mike,

No, I'm afraid you're not missing anything. Yields are low all over, by historical standards, and without extending in maturity or stepping down in quality, there's very little you can do about it.

Without recommending any specific course of action, since I don't know you or your portfolio, I would just offer up the following points of guidance.

First, let me update your numbers, since your letter was written in late January. (Sorry, folks, I'm answering as fast as I can!) As of last night, T. Rowe Price's Virginia

(PRVSX)

Short-Term Tax-Free Bond yielded 3.52%.

(PRVAX) - Get Report

Virginia Tax-Free Bond yielded 4.76%. And Fidelity

Municipal Money Market

yielded 2.68%, according to the firms' Web sites.

When I discussed your case with Patricia Houlihan, certified financial planner at

Cavill & Co.

in Oakton, Va., one of the first things that came to her mind was that, now that you are retired, you might want to check the math to make sure munis are still the appropriate bond choice for you.

An

installment of our bonds primer explains the equations, but for simplicity's sake, let's use a taxable-equivalent yield calculator. I like

this one from

Quicken.com

. Assuming you pay Virginia's top marginal income tax rate of 5.75%, which applies to incomes more than $17,000, and using the short-term Virginia fund as an example, if you plug in the numbers you will see that in the 36%

federal bracket, you'd need a 6.04% taxable yield to do as well as in the muni fund. But in the 31% bracket, you'd only need a 5.57% taxable yield, and in the 28% bracket, as long as you're getting at least 5.31% taxable, you're doing better. With many corporate bond funds easily posting yields over 5.50%, that may be a better bet for you.

On a related note, when you're comparing the yields on your money-market fund and a state-specific bond fund, don't forget to take into account the fact that the money-market fund interest will be taxable at the state level. If you're in the 36% federal bracket, the 4.76% yield on the long-term Virginia fund is worth 8.17% to you on a taxable-equivalent basis. The money-market fund is worth 4.19%. Suppose the money-market fund yield gets back up to 3.5%. It's still worth only 5.47% to you, 2.68% less than the bond fund.

The second point I want to make is about maximizing yield by stepping out in maturity or down in quality. It may not be the best idea for you. A recent

Fund Forum talked about how high-yield munis don't currently offer much value over investment-grade munis. If you put the numbers for T. Rowe's

(PRFHX) - Get Report

Tax-Free High Yield into the calculator, you can see that's the case. The 5.20% yield as of last night, which is free only from federal income tax, is worth only 8.13% to you in Virginia in the 36% federal bracket, even less than the long-term investment-grade fund. As for going long for the most yield, you seem to think that interest rates are bound to rise. If that's the case, you probably want to stay short.

Finally, a point about bond funds vs. individual bonds. The basic differences are probably clear to most investors. Bonds give you fixed payments and the virtual certainty of getting your full principal back upon maturity, but it's expensive to diversify, you can't easily reinvest the coupon payments, they're relatively illiquid and it's hard to know whether you're getting them at a good price. Funds give you neither fixed payments nor the certainty of getting your full principal back, plus they charge expenses, but you get instant diversification, reinvestment is easy, they're liquid and everybody pays the same price. In my mind, the most important thing to know when making the choice is how much of a single issue you would have to buy to avoid paying too much. Houlihan, who routinely buys Virginia munis for her clients, says "not less than $20,000, and it's better if you buy $50,000."

Thanks to reader

Marvin Snyder

for pointing out an error in

last week's column. I wrote that if a bond has a duration of 5.14 years, its price will rise by 5.14% if its yield falls by 100 basis points and fall by 5.14% if its yield rises by 100 basis points. In both instances, I ought to have said "by approximately 5.14%." As Marvin points out, if a bond is noncallable and its yield falls by a certain amount, the rise in its price will be greater than the price decline it would experience if the yield rose by the identical amount. Moreover, the longer the duration of the bond, the more it exhibits that trait. "The risk/reward profile of

noncallable bonds, especially zeros, is always biased in favor of the holder," wrote Marvin, a portfolio manager.

Send your questions to

fundforum@thestreet.com, and please include your full name.

TSC Fund Forum aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.