Municipal bonds (or “munis”) are debt securities issued by states, cities and towns to finance public projects. Their interest is typically exempt from federal taxes as well as state and local income taxes for residents living within their issuing city or town.
However, they still carry risks, including default and inflation that could wipe out your principal investment.
1. Tax-Free
Municipal bonds (also referred to as munis) are debt securities issued by cities, states, counties, school districts and other governmental entities to finance capital projects. Because munis are federally tax-exempt as well as often exempt from state and local taxes – making them an attractive investment opportunity for many investors.
As with any investment, municipal bonds carry certain risks, including credit risk (the possibility that an issuer won’t be able to meet payments) and interest rate risk (should market interest rates rise, bond values could decrease). Working with your J.P. Morgan financial advisor, you may explore strategies such as bond ladders and diversified muni portfolios which help mitigate these risks.
Investors can choose individual municipal bonds through brokers or banks, or diversify with mutual funds and exchange-traded funds (ETFs) which provide diversification and potentially higher yields. Some fund managers offer state-specific municipal funds which may offer federal, state and local tax exemption.
2. Diversification
Municipal bonds offer investors looking to protect their capital while earning tax-free income an excellent choice. You can buy them directly through brokerage firms and banks as well as via mutual funds or ETFs; when making your decision it’s essential to consider its tax-equivalent yield to assess which investment offers the greatest chance of return after taxes have been applied.
Consider also the creditworthiness of the bond issuer and duration, with longer-duration municipal bonds typically more sensitive to changes in interest rate fluctuations compared to shorter ones.
3. Reliability
Municipal bonds are considered relatively secure investments, offering a steady source of income. But like all fixed-income securities, municipals are vulnerable to default risk; though instances are rare.
Before investing, it’s essential to investigate a bond’s credit rating to reduce the chance of default. Moody’s, S&P and Fitch all assign ratings that allow investors to evaluate its quality and safety.
Many investors choose mutual funds or exchange-traded funds (ETFs) when investing in municipal bonds, because doing so gives access to bonds with various credit ratings while diversifying risk and return. Bond funds also offload the responsibility of monitoring municipalities and associated risks onto a professional manager – helping reduce expenses over time.
4. Interest Rates
As with any investment, municipal bonds carry some inherent risk. While cities and towns are unlikely to default on their debt obligations, interest rate fluctuations could push up bond market prices, potentially decreasing yields on municipal investments.
As high interest rates may robbing municipal bonds of their tax advantages, holding them in taxable accounts rather than tax-advantaged ones like 401(k)s and IRAs may be best.
Investors can purchase individual municipal bonds or invest in municipal bond mutual funds and exchange traded funds that offer more diversification. It is important that, regardless of their choice of investment vehicle, investors consider the credit ratings assigned by S&P, Moody’s and Fitch when making their decisions.
5. Maturity
Municipal bonds (temel2001fundamentals, feldstein2008handbook) are debt securities issued by municipalities to meet daily expenses and finance projects such as sewer systems or highways. When investing in municipal bonds, you are lending money directly to the issuer, who promises you regular interest payments (typically semiannual) until its maturity date (which could range anywhere between several years to over a decade away).
Since the global financial crisis, many states and local governments have implemented more fiscally responsible policies, potentially improving their ability to repay municipal bonds at maturity. But investors should still be wary of risks such as credit risk, call risk and interest-rate risk when investing in munis. Investors seeking safety should consider strategies such as bond ladders and active management as a possible safeguard.
