(MONEY Magazine) – To the investor buying individual municipal bonds, the tax-free market can resemble Russia as it was famously described by Winston Churchill: a riddle wrapped in a mystery inside an enigma. You can't find prices for most tax-exempt bonds in the newspaper. If you call several brokers, you are likely to get several different quotes for the same muni. In any event, you never know exactly how much your dealer is earning on the trade, since his commission is built into the price. And if the city, county or agency that issued your bond ever runs into financial trouble, chances are you'll hear about it first on the evening news--just as investors did in troubled Orange County, Calif.

This year, though, the veil of secrecy is lifting an inch or so. Under pressure from the Securities and Exchange Commission, the municipal bond industry is taking steps to help individuals--who directly own roughly one-third of all muni bonds--find out more about yields, prices and the fiscal health of issuers. One key project: a pilot program through New York City financial data supplier J.J. Kenny that gives you price quotes by telephone on as many as 25 bonds for just $9.95. "The muni market has been in the 17th century," says New York University finance professor Robert Lamb, who is helping develop the new programs. "Now it will be pushed into the 20th century."

The changes come just in time to help muni investors profit. Like most fixed-rate investments, municipal bonds--which communities issue to pay for day-to-day operations as well as big-ticket items like housing projects, airports and power plants--got clobbered by rising interest rates last year. Prices fell an average of 10.1%, for example, among munis that carry the triple-A-quality grade from rating services such as Moody's and Standard & Poor's. But those bonds have regained much of that lost ground in 1995, climbing 7.6% by mid-April. And unless the Federal Reserve Board hikes rates by another half a percentage point or more, many analysts, including Money's Michael Sivy (see Forecast on page 184), think bond prices will remain stable at least through the end of this year.

The muni outlook is not totally sunny: Munis could suffer a temporary setback if Orange County, which filed for bankruptcy in December after losing $1.7 billion in risky investments, tries to delay paying off any of the $1.3 billion in notes that come due between now and August. "If Orange County were unwilling to meet its obligations, that would cast a pall over the entire muni market and could depress prices generally, although nobody knows by how much," says Ian MacKinnon, fixed-income chief for the Vanguard Group.

Nevertheless, tax-free bonds remain an attractive choice for investors in the 31% federal tax bracket or higher. Historically, fewer than 1% of munis have ever defaulted, whereas the default rate for corporate bonds ranges from 1.4% per decade for triple-A-rated bonds and up to 5.7% per decade for those rated triple B, the lowest grade that is still considered investment quality. And because munis are free from federal tax-and also from state and local taxes if they are issued in your state-they can produce decidedly juicier payouts. A 10-year triple-A-rated insured muni, for instance, was recently paying roughly 5.05%, the equivalent of a taxable yield of 7.32% for someone in the 31% bracket. That was three-tenths of a percentage point higher than the 7.02% paid by comparable Treasuries. For people in the 36% and 39.6% brackets, the tax-equivalent yields were even higher: 7.89% and 8.36%, respectively.

Those advantages are particularly important to people with enough money--say, $25,000 or more--to create a diversified portfolio of individual bonds. Such people could always invest in a muni fund, of course, as those with fewer assets typically do. But a fund's yield and credit quality shift as the manager buys and sells bonds. Moreover, because funds don't have a fixed maturity, you can lose some money if you bail out after interest rates have risen (all bonds lose value when rates rise and gain value when rates fall). The buyer of individual issues, on the other hand, can ride out market swings by simply holding the bonds until they mature--provided you bought highly reliable issues on reasonable terms in the first place.

The problem with buying individual bonds today is that you practically have to be a professional to find the best deals. There are some 50,000 issuers and 1.5 million different securities in circulation, compared with 9,892 stocks on the New York, American and NASDAQ exchanges combined. Yet the muni market is thinner than those numbers suggest: Only 180 or so issues trade actively on any given day. (Actively means there are four or more trades.) If you're looking for a specific bond and your broker doesn't happen to have it, he would either offer you a substitute or buy the bond from another dealer. And since there's no central exchange where buyers and sellers meet, he may not be able to find it. As a result, investors have tended to buy whatever their broker happened to have in stock, at whatever price he quoted, without knowing whether they were getting a good deal.

The current reforms won't remedy the problem of limited inventory, but they will make it harder for brokers to overcharge you. Under Kenny's price-quote program launched in May, for example, you can get prices for specific bonds by calling 800-BOND-INF and giving the bond's multidigit CUSIP number (get it from your broker, your monthly statement or the bond itself) or else its coupon rate, maturity, issuer and date of issue. You'll get the bond's price--which includes the broker's commission--based on recent trades of that bond or similar issues. The $9.95 fee is charged to your credit card. And if you don't need all 25 price quotes that day, call back as often as you like to collect the rest. Kenny plans to offer the service on these terms at least through September, at which point Kenny and the Public Securities Association, a trade group that helped initiate the project, will decide whether to modify the program.

The Kenny system is not without flaws. For one thing, valuations are based on trades totaling $1 million in value, the standard lot for large transactions (and the price used to derive the valuations on your brokerage statement). But since personal trades usually involve smaller quantities, you can expect to pay about 2% to 3% more than the Kenny price if you're buying a bond, and to receive that much less if you're selling.

Still, the price-quote system will let you know if the broker's price is in the right ball park and, if it's not, may help you talk him down. You may even be able to reduce the premium below 2% if you are a regular customer or if the broker is eager for your future business.

Your broker too has better price data these days, which will work to your benefit in the long run. Since January, the Municipal Securities Rulemaking Board, the industry's self- regulatory group, has been collecting information on dealer- to-dealer trades and distributing it to investment professionals through data services like Kenny and Bloomberg L.P. Over the next few years, the MSRB will expand its tracking to include institutional and retail trades. None of this information had ever been available before. It should help smooth out the price disparities that now exist in the dealer-to-dealer market, says NYU's Lamb, and thus help make more uniform the prices small investors pay. Your dealer will think twice before quoting you an inflated price because he knows his competitors may be selling the same bond for less.

Equally important, your broker will soon have a better handle on the financial strength of various issuers. Beginning July 3, dealers will not be able to handle a bond unless the issuing municipality agrees to provide annual financial reports and to disclose events that might impair its ability to pay its debts, such as a big tax cut or a slump in the local economy. Again, this information will be available mainly to professionals (that may be a blessing, by the way, since city annual reports can run 300 pages). You can, however, ask your broker to alert you to any news that may affect the creditworthiness of the bonds you own--or those you are considering buying. "People who have this kind of information are less likely to get stuck with mediocre bonds-such as those issued by certain hospital authorities that are suffering financially because of rising operating costs and increased competition," says Jim Lynch, editor of Lynch Municipal Bond Advisory ($350 a year; 212-663-5552).

BUYING TIPS

Besides taking advantage of the new data, you can improve your chances of getting a good deal by following these tips:

CHOOSE A BROKER WHO SPECIALIZES IN MUNIS. "You really need expert help," says John Markese, president of the American Association of Individual Investors. So even if you already have a stockbroker, you might consider using a bond specialist to buy munis. And to make sure you get a good selection of bonds, do business with a national firm that has a big inventory or a regional firm that specializes in the bonds you want.

SHOP AROUND. If you're selling a bond, tell your broker to put it out for competitive bids. That means he'll call what's known as a broker's broker, an intermediary who arranges sales between dealers. If you are buying, get quotes from three different brokers. Have each explain how the bond he likes compares with others of similar quality, including those touted by his competitors.

STICK TO MATURITIES OF 10 YEARS OR LESS. Although longer-term bonds have slightly higher yields, says Richard Ciccarone, director of tax-exempt research at Kemper Securities, their prices fluctuate more when interest rates change and "you're not getting paid enough extra at today's rates to justify the risk of tying up your money for so long." You can give yourself added protection against interest-rate fluctuations by creating a bond "ladder" consisting of issues with different maturities.

DIVERSIFY. Buying bonds from your home state carries an extra tax boost, but putting all your eggs in that one basket would increase the risk that a natural disaster or local economic slowdown could torpedo your portfolio's value. Experts advise against investing more than 60% of your bond money in one state.

CONSIDER PRE-REFUNDED OR INSURED BONDS. Pre-refunded issues, which typically yield about one-fifth of a percentage point less than standard munis, carry virtually no credit risk because they are backed by U.S. Treasuries, notes Lauren Eastwood, who is an analyst with the municipal bond firm Gabriele Hueglin & Cashman. Insured bonds have payouts just one-tenth of one percentage point below those of comparable uninsured bonds but are slightly more risky than pre- refunded issues.

IF YOU FIND A BOND YOU LIKE, ACT PROMPTLY. If you don't move within a day or so, you risk the bond's being sold to someone else. "If you think you want a particular bond but haven't quite decided, ask your broker to 'take the bond firm' or 'circle' it," advises Sam Fales, a vice president with the regional brokerage firm Legg Mason. Both terms mean that the firm's traders should let your broker know if someone else wants to buy the bond within the next hour or so. Your broker will then have five minutes to see whether you want it instead.