“And collect up to $3,000 a month in TAX FREE income starting as early as Feb. 13, 2008.”

That’s how a recent email teaser ad from Stansberry and Associates for Steve Sjuggerud’s True Wealth newsletter opens — and this kind of investment is always very appealing for folks when stocks are in crisis mode, as appears to be the case today. So, this one seems to be worth a look.

The promise is that you can “Live Like a Florida Retiree Without Ever Leaving Home.” Man, I was hoping to put off living like a Florida retiree for a few years, at least … I just can’t work up an appetite for dinner at 4:30. I have been known to leave my turn signal on for 20 minutes, though, and my hairline is definitely receding at a rapid pace, so perhaps I’m halfway there already.

Kidding! I kid because I love.

Anyway, back to business. This ad tells us that getting tax-free income is one of the main benefits of retiring in Florida, and that they have a system where — even if you don’t live in Florida — they can get you “$1,000 to $3,000 in extra tax-free income every 4 weeks.”

Sounds pretty enticing, no?

And this teaser has all the hallmarks of the great ones: A long list of individuals and the monthly income they’re pulling from their investments in this system (without, of course, noting how much capital they’re investing to get that income); a reference to a government mandate or law that authorizes this special income; and a few quotes from reputable business magazines that give it gravitas.

The law was apparently passed in 1977, and it “authorizes states like Florida to distribute tax-free income to investors – no matter how old you are or how much you earn.”

And they even call it an “obscure law” — which seems to be code for, “We don’t think you understand legal stuff.” They actually do give the public law number, too, which is 94-455.

(Quick learning opportunity: That number means this was the 455th law passed by the 94th Congress. The law was technically passed in the fall of 1976 and signed by President Ford — hence the name, “Tax Reform Act of 1976,” but it applied beginning in the 1977 tax year.)

And the quotes are pretty solid, too:

From Fortune: “”Fixed-income investors looking for juiced-up yields have been finding them lately in [Virtual Florida Retirement].”

And: “Steven Goldberg, a business reporter for Kiplinger’s Personal Finance, recently said: ‘For yield-starved investors, it’s hard to find better deals….'”

So we’ve got all the ingredients of a great teaser, except the details — what’s the investment?

I’ll quote:

“The law permanently changed the tax code, making it possible for state governments to partly fund tax-free monthly payments to thousands of Americans… Simply put, this obscure law made possible one of the biggest boons to U.S. retirees … State governments like Florida, California, and New York constantly fund the construction and maintenance of hospitals, schools, roads, bridges, and public buildings … Because these projects involve billions of dollars, state governments came up with a unique investment plan some years back: They’d help pay dividend checks to participating tax-paying citizens across the country… and in return, you’d get a stake in these government projects.”

So that’s what we’re being teased with here — if you are at all experienced as an investor, or if you’re interested in income investing, you are probably aware that this is simply, to this point, a complicated teaser for municipal bonds. Municipal bonds are just like treasury bonds — except instead of lending your money to the federal government, you’re lending to a local government, usually for some kind of project or special need like infrastructure upgrading, school building, etc.

Municipal bonds provide income that is tax free at the federal level, and sometimes at the state level, too, if you live in the same state as the bond originates from.

But the Stansberry folks aren’t telling us to buy municipal bonds — they have something slightly more complicated to tease:

And the clues?

“It would be logistically very complicated for each state to administer the monthly dividends and send checks to U.S. citizens all over the country. As a result, private companies have stepped in … In other words, private companies (listed on U.S. stock exchanges) act as intermediaries.”

The next distribution is on February 13 — they list a bunch of future distribution dates, but say that there are four favorites that they recommend, all of which pay monthly in the middle of the month.

What is being teased here are Closed End Funds that hold municipal bonds. That’s what both the quotes were about from the financial magazines I noted above, and they are all, technically, companies that hold bonds, don’t pay taxes on the income, and pass through the dividend income to shareholders.

For those unfamiliar with Closed End Funds (CEFs), they’re just like regular mutual funds, except they have a set number of shares (like a stock does) and they trade on an exchange, just like a stock or an ETF. ETFs and CEFs are often confused, but ETFs have flexible numbers of shares, are usually index-based (CEFs are usually actively managed by stock/bond pickers) and usually don’t trade at a significant premium or discount.

That means that pricing of Closed End Funds is not determined just by the asset value of their holdings, but by how much investors are willing to pay for them on any given day — so these funds often trade at either a discount or a premium, depending on the popularity of the asset class at that moment and on the desirability of the fund’s management or holdings … on average, most of them trade at a fairly small discount most of the time, but steep discounts and huge premiums are possible on either end of the scale.

Many of these bond funds use leverage (borrowed money) to boost their returns, with leverage of about 30-40% being pretty common. And there are all kinds of distinctions between different kinds of bonds — all in all, there are at least 250 closed end municipal bond funds, many of which are very similar.

The bad news? Of those 250+, the clues given don’t allow us to say with certainty which four funds Sjuggerud is teasing — even if I restrict the universe to those funds that use leverage (you pretty much have to borrow money to get the 8%+ returns that are teased here — unleveraged funds average more like 4-5%), the universe is still quite large.

But I can at least tell you how you can find decent closed end muni funds on your own:

There are two excellent websites for searching and sorting these funds: etfconnect.com, which is owned by Nuveen (one of the companies that manages these funds), and closed-endfunds.com, which is run by the Closed-End Fund Association. Both offer more or less the same level of data about all the closed-end funds that are generally available, both muni bond funds and all the other kinds of closed-end bond and stock funds.

Generally, leveraged closed-end funds are a very good bet in a falling interest rate environment, so you might get lucky there if rates keep getting cut, since the funds might be able to “leverage up” at lower interest rates and increase their payouts to you. At the same time, in theory, the bonds they hold would be more valuable if overall muni bond rates fall, so they might get decent capital gains as well.

That’s assuming, of course, that a massive recession doesn’t come along and make municipalities default on their loans. Defaults, especially catastrophic ones like New York City in the 1970s and Orange County in the mid-1990s, are very rare.

What is generally recommended is that you look for are decent managers with a long track record, low expenses relative to their peers, and a diversified portfolio (unless you live in one of the big states that offers a state tax break on their own bonds, in which case you might want to look at a fund that focuses just on that state — probably a dozen or so of the largest states have single-state funds available).

Both of the websites I noted, and I link to them below, let you see how long the fund has existed, how much they charge for management fees, how long the managers have been in charge, and their return compared to peers over various time frames.

What are the bad things about municipal bond funds?

Well, unlike the actual bonds, they generally don’t have a maturity date — so there’s no guarantee of a return of your principal at a certain date. Owning individual munis instead of a fund, if you have a relatively large portfolio that’s big enough to get diversification, might give more protection against loss of capital due to rising interest rates. But you’d probably end up paying someone to manage it for you, anyway, unless you love this stuff. Municipal bonds are one of the few asset classes where the majority of the assets are held by individual investors, so it certainly wouldn’t be crazy of you to want to build your own portfolio of these if you have a decent broker and want to put some time in.

Leverage works both ways — in a rising rate environment, leveraged bond funds are very risky.

Costs can be very high for these funds — you might find this shocking if you’re used to regular stock and bond funds, but it’s not unusual for management fees to be 1.5-2% or higher annually. That’s a lot to give up for an investment that you’re hoping will yield 7-8%, and they don’t stop charging the management fee if returns go down.

Keep in mind that most of the big low-cost no-load mutual fund companies sell municipal bond funds, too, including some very cheap ones from Vanguard if you don’t want to deal with a closed end fund. Most of them don’t use leverage or offer outsize returns, but they may help you sleep better and they’re just as tax-free.

So … that’s a quick tutorial in municipal bond funds. Just a note to close: The tease quoted both Fortune and Kiplinger’s as having articles about these investments — I’ve read those articles …

Fortune’s was published about four years ago and noted that “these specialized funds offer large payouts — but you’d better act fast.” Though, to be fair, that was because rate hikes were likely … that doesn’t seem to be the case at the moment.

The Kiplinger’s article, specifically teased as “recent”, was from the Spring of 2005 — it’s not on the free web at the moment, but a more recent article on the same topic from the same magazine is available here for your edification.

And just to be clear that this is not a wacky, out of left field recommendation, the king of bonds, Bill Gross, is also talking up muni funds — in the last Barron’s Roundtable article to launch 2008 recommendations, he mentioned one particular pick that he likes:

“My first suggestion is really a prototype. Typically readers rush in and bid up these recommendations right after publication, and all the value disappears in a day or two. So, be careful of your timing, and check out the closed-end-funds section of Barron’s for other potential values. Look for funds that trade at a discount of at least 10% to net asset value, and yield 5% or more. With that build-up, my pick is Van Kampen Select Sector Municipal Trust. It has a 5.5% yield and sells at a 10% discount to net asset value. When you can get a 5.5% municipal yield relative to 4.3%-4.4% Treasuries, that tells you something. Most of these funds are leveraged, as is this one. They’re dependent on cheap financing. To the extent that the Fed lowers interest rates from 5.25% to 3.25% or lower, these funds have the potential to raise their dividends. I’m not forecasting what Van Kampen will do, but generically lower rates create the potential for higher yields.”

So there you have it. If you’re interested in income investing, and in tax-protected income and possibly some “safety”, then municipal bond funds might be a decent place to look … but I think a portfolio of these closed end funds, or a position in a decent mutual fund in this area, could be chosen pretty easily by most investors. If you’re comfortable comparing things like leverage amounts, expense ratios, and historical returns, I’d be hard pressed to say that a newsletter is going to choose funds that are significantly different than those you could easily select on your own from closed-endfunds.com or etfconnect.com.

Oh, and some quick math to close our circle: they teased $1,000 to $3,000 in income a month (at least, that’s the lowest amount the teased). If you’re getting 8%, which seems a decent number to shoot for from the leveraged closed-end funds, you’ll need to buy $150,000 worth of shares for a $1,000 monthly payment … or $450,000 for the goal of $3,000 a month. Just like to put some real “input” numbers to go with the “output” numbers they love to tease us with.

Happy investing, everyone.