- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Is it possible to lose money on municipal bonds?
These funds have a low risk of losing value, and the interest they pay is consistent. They also pay a very low interest rate as a result of their safety. Risk and reward are inextricably linked: a lesser risk equals a lower payoff.
Are municipal bonds currently a good investment?
- Municipal bonds were one of the most stable fixed income asset classes in 2021, with positive returns and minimal volatility across a wide range of credit and maturity.
- New issuance slightly exceeded the record set in 2020, but supply was quickly absorbed by surprisingly continuous fund inflows.
- Record state and local revenues, stimulus spending, minimal defaults, and idiosyncratic strength helped credit outperform by the largest margin in more than a decade.
Despite substantially higher interest rates, municipal bonds kept their value throughout 2021, generating among of the highest relative returns among fixed income assets. The asset class is poised for a great technical and fundamental year in 2022. Looking ahead, the Federal Reserve of the United States (Fed) appears to be refocusing on fighting inflation, which could create headwinds for fixed income in the near term.
In New Jersey, are municipal bonds tax-free?
The main issues for investors considering municipal bond funds were explored in a previous post. National Muni Bond ETFs are a low-cost and straightforward approach to participate in municipal bonds. When municipal bond closed-end funds (CEFs) are trading at an especially substantial discount to their portfolios’ net asset values, they can be a more appealing way to invest in the area. This essay, written exclusively for New Jersey taxpayers, compares the most appealing New Jersey municipal bond mutual funds and CEFs against national ETFs and CEFs.
Income Taxes in New Jersey
Municipal bond interest is not taxed at the federal level.
Furthermore, interest on municipal bonds issued by municipalities within their own state, including bonds issued by the state, is generally exempt from taxation.
New Jersey levies a 6.37 percent tax on income between $75,000 and $500,000, and an 8.97 percent tax on income exceeding $500,000.
For NJ investors, the goal of this article is to examine the relative attractiveness of national muni bond funds and NJ muni bond funds.
The yields on the NJ-specific muni funds have been grossed up by 6.37 percent to make fair comparisons.
New Jersey Municipal Bond Mutual Fund is a mutual fund that invests in municipal bonds in New Jersey.
The Vanguard New Jersey Long-Term Tax-Exempt Fund (VNJTX) is a mutual fund that invests in municipal bonds issued by the state of New Jersey.
It is actively managed, yet it stays extremely close to the Bloomberg Barclays NJ Muni Fund Index, which is its benchmark index.
It has a relatively low cost-to-income ratio.
17% of the total
VNTJX had a 3.41 percent yield as of May 31, 2019.
When the yield is increased by 6.37 percent, the adjusted yield is 3.64 percent.
The fund has a 5.1-year duration.
This is our best NJ muni mutual fund because it is managed almost like an index fund, captures the NJ muni market well, and has an extremely low expense ratio relative to competing products.
Municipal Closed-End Fund of New Jersey
The BlackRock MuniHoldings New Jersey Quality Fund is now our favorite municipal bond fund in New Jersey (MUJ).
The following are some of the reasons why we appreciate it:
- Our proprietary CEF return forecasting methodology predicts a high expected residual return.
ETFs that invest in municipal bonds on a national level. We include two very large and liquid low-cost national municipal bond exchange-traded funds (ETFs) that we have highlighted in previous articles for comparison purposes: iShares National Muni Bond ETF (MUB) and Vanguard Tax-Exempt Bond ETF (VTEB). Both are index funds that are passively managed and track the same benchmark index, the S&P National AMT-Free Municipal Bond Index, therefore their features and holdings are very similar. We also include the iShares iBonds Sep 2020 Term Muni Bond ETF (IBMI) to reflect the short end of the national muni market in order to define the muni yield curve.
The National Muni CEF is a non-profit organization dedicated to improving public transportation in
In addition, we include AllianceBernstein National Municipal Income Fund, our current favorite national muni CEF, for comparison purposes (AFB).
AFB, like most national muni CEFs, has a substantially longer duration than VTEB and MUB, the two key national ETFs.
NAV Discount at MUJ.
MUJ’s NAV was $15.82 on May 31, 2019, and its price was $13.92, thus it was trading at a 12.0% discount to NAV(/15.82).
For a price of $13.92, that’s a value of $15.82.
That NAV’s worth is unquestionably strong.
The portfolio of AFB is neither subjective nor difficult to value.
It is made up of municipal bonds that are traded on the open market.
Even if the NAV discount never goes away, the investor benefits from the whole $15.82’s economic value and ability to generate cash flow.
The dividend rate would have been 3.98 percent (.0525 x 12 / 15.82) instead of 4.53 percent if AFB had traded at its NAV of $15.82 on May 31, 2019.
That’s a.55 percent increase in yield just for buying on the cheap!
NAV Discount is a value factor.
We are unable to discuss all of our unique factors in detail.
However, we’ll take a closer look at the one we think is most important: the NAV Discount.
Purchasing a CEF at a discount to its portfolio’s NAV is clearly a value strategy.
According to our research, the NAV discount factor is the most powerful CEF selection factor we have.
One of our study tests for this factor is depicted in the graph below.
We start our experiment at the end of 2012, when FactSet first made NAV data available.
We create a “Top 5” portfolio of the five CEFs with the greatest NAV discounts at the conclusion of each month.
Each carries a 20% weight.
We calculate the portfolio’s monthly residual return, then re-select and rebalance the “Top 5” portfolio at the end of the following month, and so on.
Similarly, we create a “Bottom 5” portfolio of the five CEFs with the smallest, or most negative, NAV discounts at the end of each month, re-selecting and rebalancing monthly.
Model in general.
Within the national closed-end muni fund universe, we offer test results for our overall return predicting model.
This covers the effects of all the components we use to forecast residual return, as well as the effects of systematic return factors, such as distribution yield.
The blue line is the monthly rebalanced cumulative log of total return (not residual return) of an equal-weighted portfolio of the five single-state muni CEFs with the best total return forecasts.
Since 2012, the average log of total return per year has been 9.0 percent.
The orange line does the same thing as the blue line, except it invests in the five stocks with the lowest (or most negative) total return estimates.
The return on that investment was -8.7%.
The green line depicts the strategy’s long-to-short implementation.
It has an annual return of 17.6 percent.
On both the long and short sides, the results have been robust and constant.
CEFs are superior.
From a yield/risk perspective, we’ve already seen that the NJ mutual fund, VNJTX, outperforms the basic national muni ETFs, VTEB/MUB.
A comparison of their overall return/risk tradeoffs is shown in the graph below.
The two CEFs are preferable to the ETF alternatives in that they are presently substantially above the muni yield curve, thanks to our exclusive CEF alpha forecasts.
The option you choose is determined on the interest rate outlook.
This graph differs slightly from the yield/risk tradeoffs graph above.
In our alpha model, AFB has a very high total return forecast.
The total return prediction for MUJ isn’t quite as optimistic.
Furthermore, MUJ has a very long duration.
Bottom line:AFB is a more appealing muni fund than MUJ, and it is our preferred muni fund for New Jersey residents (despite the fact that it is a nationwide fund rather than a New Jersey-specific fund) who are ready to take on the interest rate risk.
Investors who expect interest rates will rise in the future may pick the VNJTX NJ municipal mutual fund.
Are bonds safe in the event of a market crash?
Down markets provide an opportunity for investors to investigate an area that newcomers may overlook: bond investing.
Government bonds are often regarded as the safest investment, despite the fact that they are unappealing and typically give low returns when compared to equities and even other bonds. Nonetheless, given their track record of perfect repayment, holding certain government bonds can help you sleep better at night during times of uncertainty.
Government bonds must typically be purchased through a broker, which can be costly and confusing for many private investors. Many retirement and investment accounts, on the other hand, offer bond funds that include a variety of government bond denominations.
However, don’t assume that all bond funds are invested in secure government bonds. Corporate bonds, which are riskier, are also included in some.
Opportunity cost
Municipal bonds’ tax advantages aren’t as valuable if you’re in a lower tax band as they are if you’re in a higher tax bracket.
If that’s the case, you could be better off putting your money into alternative investments for a larger return.
They may not be liquid
If you need money quickly, you should be aware that municipal bonds may have liquidity problems.
You might not be able to find an active market for your bonds, which means you won’t be able to sell them when you want at the price you want.
Why are municipal bonds in decline?
Some economists predict a reduction in muni demand this year due to a predicted slowing in household savings, which grew during the pandemic, particularly among the wealthy. The demand for tax-exempt debt has long outstripped annual issuance.
Are municipal bonds a high-risk investment?
- Municipal bonds are a wonderful option for consumers who want to keep their money while earning tax-free income.
- General obligation bonds are used to quickly raise funds to meet expenses, whereas revenue bonds are used to fund infrastructure projects.
- Both general obligation and revenue bonds are tax-free and low-risk investments, with issuers who are quite likely to repay their loans.
- Municipal bonds are low-risk investments, but they are not risk-free because the issuer may fail to make agreed-upon interest payments or be unable to repay the principal at maturity.