Municipal securities, or “munis,” are bonds issued by states, cities, counties, and other government bodies to raise funds for public projects such as roads, schools, and other infrastructure.
Munis pay a predetermined amount of interest (typically semiannually) and refund the principle on a predetermined maturity date. The majority of municipal bonds are offered in $5,000 increments and have maturities ranging from 2 to 5 years to very long (30 years).
When considering a municipal bond investment, keep in mind that no two municipal bonds are alike, and carefully assess each one, making sure to get the most up-to-date information on both the bond and the issuer. See FINRA’s Investor Alert Municipal BondsImportant Considerations for Individual Investors for further information.
Buying and Selling Munis
Some municipal bonds have a higher level of liquidity than others. Some bonds trade frequently, while others may go weeks without any activity (no interested buyers or sellers). Municipal bonds, in general, are more susceptible to supply and demand pressures than other fixed-income securities. As a result, you’re taking on more market risk: If your bond is out of favor with other investors when you need to sell it, the price you get in the secondary market will fall. Of course, munis, like all bonds, are susceptible to interest rate risk: if rates rise faster than your bond’s rate, the bond’s secondary market value drops.
Because of the overwhelming amount of muni bonds available and the tremendous competition among dealers for a piece of the pie, muni investment should be approached with caution. Do your homework, beginning with selecting an investment professional with a track record of success in municipal securities.
When considering a municipal bond investment, keep in mind that no two municipal bonds are alike, and carefully assess each one, making sure to get the most up-to-date information on both the bond and the issuer.
Munis and Taxes
The principal reason why most private investors purchase municipal bonds is to benefit from preferential tax treatment on the interest they earn. The great majority of municipal bond interest is tax-free in the United States. Indeed, municipal securities are the only ones that fall within this category.
Furthermore, if you live in the state or city that issued the bond, your interest income may be exempt from state or city taxes. Residents of all states are excluded from paying taxes on bonds issued by Puerto Rico, Guam, and other US territories.
The federal government does not exclude all municipal bonds from taxation. Municipal bonds that are taxable may be issued to fund projects that the federal government would not fund. To make up for the lack of a tax advantage, these bonds often have higher yields than tax-exempt municipal bonds, and are more in line with corporate or agency bond rates.
The AMT (alternative minimum tax) is a tax that some persons must pay. The AMT is calculated using a separate set of principles than your regular income tax calculation, but you must pay whichever calculation is higher. The AMT may apply to investors who buy “private activity” municipal bonds, which are bonds that aren’t solely used for government activities. Interest gained on these “private activity bonds” cannot be deducted under AMT rules, unlike interest earned on other municipal bonds, including 501(c)(3) private activity bonds, and may result in an AMT payment. Before advising a tax-exempt investment, a reputable financial adviser should assess your AMT liabilities. A tax professional’s counsel is also recommended.
Is it better to buy short-term or long-term municipal bonds?
Municipal bonds (also known as municipal debt) are a type of debt “State, city, county, and other local agencies issue debt securities to support day-to-day commitments as well as capital projects such as the construction of schools, roadways, and sewer systems. When you buy municipal bonds, you’re effectively lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or a combination of the two “I am the principle.” The maturity date of a municipal bond (the day on which the bond’s issuer repays the principal) could be years away. Short-term bonds will mature in one to three years, whereas long-term bonds will take a decade or more to maturity.
Municipal bond interest is generally tax-free in the United States. If you live in the state where the bond was issued, the interest may be free from state and local taxes. Bond investors are often looking for a consistent stream of income payments and, when compared to stock investors, are more risk conservative and concerned with preserving rather than developing capital. Due to the tax benefits, tax-exempt municipal bonds typically have lower interest rates than taxable fixed-income assets such as corporate bonds with equal maturities, credit quality, and other characteristics.
- States, cities, and counties issue general obligation bonds that are not backed by any assets. General obligations, on the other hand, are backed by the government “the issuer’s “full faith and credit,” which includes the ability to tax inhabitants in order to pay bondholders.
- Revenue bonds are backed by earnings from a specific project or source, such as highway tolls or lease fees, rather by the government’s taxing power. Some revenue bonds are available “The term “non-recourse” refers to the fact that bondholders have no claim to the underlying revenue source if the revenue stream ceases to exist.
Municipal borrowers also occasionally issue bonds on behalf of private businesses such as non-profit universities and hospitals. The issuer, who pays the interest and principal on the bonds, often agrees to reimburse these “conduit” borrowers. The issuer is usually not compelled to pay the bonds if the conduit borrower fails to make a payment.
Where can investors find information about municipal bonds?
The Municipal Securities Rulemaking Board’s Electronic Municipal Market Access (EMMA) website makes municipal securities documentation and data available to the public for free. You will have access to:
- Economic reports and events that may have an influence on the municipal bond market are listed on this calendar.
It’s worth noting that many issuers have dedicated websites or webpages for municipal bond investors. Some issuers link to those pages from their EMMA main page. Learn how to use EMMA to locate issuer homepages.
In 2009, the Securities and Exchange Commission recognized EMMA as the official depository for municipal securities disclosures. The MSRB is supervised by the Securities and Exchange Commission (SEC). The MSRB is a self-regulatory body whose objective is to promote a fair and efficient municipal securities market in order to safeguard investors, state and local governments, and other municipal entities, as well as the public interest. The disclosure materials are not reviewed by the SEC or the MSRB before they are posted on EMMA.
What are some of the risks of investing in municipal bonds?
Municipal bonds, like any other investment, carry certain risk. Municipal bond investors are exposed to a number of dangers, including:
Call it a gamble. Call risk refers to the possibility of an issuer repaying a bond before its maturity date, which could happen if interest rates fall, similar to how a homeowner might refinance a mortgage loan to take advantage of reduced rates. When interest rates are constant or rising, bond calls are less likely. Many municipal bonds are “callable,” thus investors who plan to hold a bond to maturity should look into the bond’s call conditions before buying it.
There is a credit risk. This is the risk that the bond issuer will run into financial difficulties, making it difficult or impossible to pay interest and principal in full (the inability to do so is known as “default”). For many bonds, credit ratings are available. Credit ratings attempt to measure a bond’s relative credit risk in comparison to other bonds, yet a high grade does not imply that the bond would never default.
Interest rate risk is a concern. Bonds have a set face value, which is referred to as the “par” value. If bonds are held to maturity, the investor will get the face value of the bond plus interest, which might be fixed or variable. The market price of the bond will grow as interest rates fall and fall as interest rates rise, hence the market value of the bond may be greater or lesser than the par value. Interest rates in the United States have been historically low. If interest rates rise, investors who hold a cheap fixed-rate municipal bond and try to sell it before it matures may lose money due to the bond’s lower market value.
There is a chance of inflation. Inflation is defined as a widespread increase in prices. Inflation diminishes purchasing power, posing a risk to investors who are paid a fixed rate of interest. It may also result in higher interest rates and, as a result, a decrease in the market value of existing bonds.
There’s a danger of running out of cash. This refers to the possibility that investors may be unable to locate an active market for the municipal bond, prohibiting them from buying or selling the bond when they want and at a specific price. Because many investors purchase municipal bonds to hold rather than trade them, the market for a given bond may be less liquid, and quoted values for the same bond may range.
In addition to the risks, what other factors should you consider when investing in municipal bonds?
There are tax implications. Consult a tax specialist to learn more about the bond’s tax ramifications, such as whether it’s subject to the federal alternative minimum tax or qualified for state income tax benefits.
Brokerage commissions. The majority of brokers are compensated by a markup on the bond’s cost to the firm. It’s possible that this markup will be revealed on your confirmation statement. If you are charged a commission, it will appear on your confirmation statement. You should inquire about markups and commissions with your broker.
Do municipal bonds have a monthly payment?
The Tax Benefits of Municipal Bonds The majority of municipal bonds and short-term notes are issued in $5,000 or multiples of $5,000 denominations. Interest on bonds is usually paid every six months (though some forms of bonds work differently), while interest on notes is usually paid when the note matures.
What is the average length of a bond?
The term, or number of years till maturity, of a bond is normally determined when it is issued. Bond maturities can range from one day to 100 years, with the bulk falling between one and 30 years. Short-, medium-, and long-term bonds are all terms used to describe bonds. The term “short-term bond” refers to a bond that matures in one to three years. Bonds having maturities of four to ten years are known as medium- or intermediate-term bonds, while those with maturities of more than ten years are known as long-term bonds. When the bond reaches its maturity date, the borrower satisfies its financial commitment, and you receive the final interest payment as well as the original amount you borrowed (the principal).
In 2021, are municipal bonds a decent investment?
- 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.
When are municipal bonds available for sale?
When interest rates are expected to climb dramatically, this is the most important sell signal in the bond market. Because the value of bonds on the open market is primarily determined by the coupon rates of other bonds, an increase in interest rates will likely lead current bonds your bonds to lose value. As additional bonds with higher coupon rates are issued to match the higher national rate, the market price of older bonds with lower coupons will fall to compensate new buyers for their lower interest payments.
Is it wise to invest in municipal bonds in 2022?
The key drivers of the municipal market are all positive, therefore 2022 is expected to see ongoing robust demand for municipal bonds. Taxes are first and foremost. Investors are still concerned about increasing taxes and will do everything possible to avoid them, keeping demand high.
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.
What is the interest rate on municipal bonds?
You can invest in either ordinary corporate bonds or tax-exempt municipal bonds. Corporate bonds have a yield of 7%, while tax-free municipal bonds have a yield of 5%. Which of the two investing options is better for your portfolio?
Is municipal bond interest taxable?
Residents of the issuing state are generally excluded from federal and state taxes on income earned from municipal bonds. While interest income is tax-free, any capital gains delivered to the investor are taxable. The Federal Alternative Minimum Tax may apply to some investors’ earnings (AMT).
Is it possible to pay off municipal obligations early?
Many bonds allow the issuer to return the bond in full or in part before the maturity date. In exchange for the early debt repayment, the investor’s capital is returned with a premium.