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 bond funds now safe to invest in?
- 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.
What are the potential dangers of 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.
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.
Is bond investing a wise idea in 2021?
Because the Federal Reserve reduced interest rates in reaction to the 2020 economic crisis and the following recession, bond interest rates were extremely low in 2021. If investors expect interest rates will climb in the next several years, they may choose to invest in bonds with short maturities.
A two-year Treasury bill, for example, pays a set interest rate and returns the principle invested in two years. If interest rates rise in 2023, the investor could reinvest the principle in a higher-rate bond at that time. If the same investor bought a 10-year Treasury note in 2021 and interest rates rose in the following years, the investor would miss out on the higher interest rates since they would be trapped with the lower-rate Treasury note. Investors can always sell a Treasury bond before it matures; however, there may be a gain or loss, meaning you may not receive your entire initial investment back.
Also, think about your risk tolerance. Investors frequently purchase Treasury bonds, notes, and shorter-term Treasury bills for their safety. If you believe that the broader markets are too hazardous and that your goal is to safeguard your wealth, despite the current low interest rates, you can choose a Treasury security. Treasury yields have been declining for several months, as shown in the graph below.
Bond investments, despite their low returns, can provide stability in the face of a turbulent equity portfolio. Whether or not you should buy a Treasury security is primarily determined by your risk appetite, time horizon, and financial objectives. When deciding whether to buy a bond or other investments, please consult a financial advisor or financial planner.
What exactly are Bam municipal bonds?
Build America Mutual Assurance Company (abbreviated as BAM) is a mutual, monoline bond insurer specializing in vital public-purpose municipal bonds in the United States. The company has guaranteed over $65 billion in par amount for over 3,300 member-issuers since its launch in July 2012. It insured $8.36 billion in par in 653 new-issue insured transactions in 2018. BAM also discloses and updates credit profiles for each transaction it covers. There are now almost 6,000 available. The firm is the preferred source of debt financial guaranty insurance for National League of Cities member municipalities. When BAM was first released, the NLC endorsed it.
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.
Is now a good time to buy municipal bonds?
Municipal bonds have attracted a lot of money from investors looking to decrease risk and taxes. Some investors may be concerned about price drops as the Federal Reserve seeks to raise interest rates. However, muni bonds may see higher coupon rates, and a well-constructed portfolio can still meet long-term objectives, according to financial experts.
Are municipal bonds inherently more secure than corporate debts?
When deciding whether to purchase corporate or municipal bonds, there are a number of considerations to consider. The quality of the corporation issuing the bond, the tax consequences, yield, liquidity, and how the money earned through the issuance of the bond will be used are some of the most important of these variables.
Quality of Issuer
The issuer’s quality is one of the first things you should look into before buying a bond or any other financial instrument. Bond issuers will have varying credit ratings, which means that investing in the securities they’ve made accessible exposes you to credit risk.
Bond issuer credit ratings are provided by two agencies: Moody’s and Standard & Poor’s. The rating scale used by Moody’s spans from C to AAA, with AAA being the highest attainable grade. Standard & Poor’s has a rating system that ranges from D to AAA, with AAA being the highest attainable rating.
Higher ratings indicate that the bond’s issuer is less likely to default. After all, individuals who invest in the security stand to lose if the corporation that issued it fails to meet its obligations.
Corporate Bonds Come With Higher Default Rates
Corporations issue corporate bonds, and each corporation is distinct. Some people make more money than others, some have superior management teams, and some will continuously fulfill their duties while others will fail.
Instruments issued by corporations have a higher default risk than municipal bonds, therefore it’s very crucial to pay attention to how rating agencies grade the bond before you invest.
The good news is that even businesses rarely go bankrupt. Only approximately 0.13 percent of companies that issue bonds default, according to the Corporate Finance Institute.
Tax Implications
You must pay taxes on all income you earn, whether it is from a side hustle, your day job, or investment returns. However, not all forms of income are taxed in the same way. When determining whether to invest in corporate or municipal bonds, consider the following tax effects.
How Corporate Bonds Are Taxed
Corporation-issued bonds are sometimes referred to as taxable bonds since the revenues earned from these investments are subject to both federal and state income taxes at the general income tax rate. Your tax bracket determines the exact rate you’ll pay on your returns.
How Municipal Bonds Are Taxed
Gains from municipal bond investments are always tax-free on the federal level and are frequently tax-free on the state level as well. The tax exemption is effectively a “thank you” from both the federal and local governments for investing in projects that benefit your community with your money.
While munis are immune from state and local taxes in the vast majority of circumstances, this is not always the case. If you buy a municipal bond from a municipality other than the one where you live, for example, your local authorities may choose to tax the bond’s returns at the usual local income tax rate.
For example, if you live in New York City and invest in a municipal bond issued by a government body in Florida, New York City may charge you its standard local tax rate on the investment’s profits.
Yields
Bond yields fluctuate dramatically based on the credit of the issuing institution, the maturity period of the bond, and other considerations.
In general, the following is how corporate and municipal bond yields compare:
Corporate Bonds Generally Have Higher Yields
Local governments are well-respected institutions with a track record of good financial management. Corporations, on the other hand, will have a wide range of financial strength and creditworthiness.
Corporate bonds have higher interest rates than government bonds because companies are typically less creditworthy than governments. After all, if corporate bond yields were the same as government bond yields, no one would lend to riskier businesses. Who wants to buy a corporate bond when you may get the same returns by investing in lower-risk municipal bonds?
Munis Provide Small Gains
Bonds issued by the government come with a reduced default risk and so are the safer alternative for investors. When it comes to investing, however, safer options tend to yield lesser returns, and municipal bonds are no exception.
The extremely low default risk is incorporated in the pricing of these bonds, resulting in lower interest rates, smaller interest payments, and poorer overall returns.
That is, until taxes are factored in. A high-income earner, for example, may discover that municipal bonds are a better fit because they are tax-free on both the state and federal level. By contrast, much of the profits on corporate bonds would be wiped by taxes for an investor in the highest tax bracket.
Liquidity
Whether investing in bonds or any other asset, investors should constantly consider liquidity. Liquidity relates to the ease or difficulty of changing an investment back into cash if desired.
Bonds with low liquidity will be difficult to convert into cash before their maturity dates, whereas bonds with high liquidity will be easy to offload and turn into spendable money on demand.
Corporate Bonds Are Often Less Liquid
While any type of bond can be sold on the secondary market, there must be a buyer for the bond to be sold. Investments in high-risk bonds and other corporate bonds may become illiquid in some situations if no other investors are interested in buying them.
Furthermore, when the economy and markets are doing well, bond liquidity decreases. During bull markets, investors prefer not to have their money invested in fixed-income assets, preferring instead to focus on the higher return potential of equities.
Municipal Bonds Are Highly Liquid
The municipal bond market is quite active, and municipal bonds are often easier to sell than corporate bonds. That’s because muni bonds are issued by entities that are all but guaranteed to meet their commitments while giving tax benefits, making them appealing investments for high income individuals.
How Funds Are Used
Investors are becoming increasingly worried about how their money is being used. In fact, there’s a whole industry devoted to social impact investing, which is investing in assets that use your money to help causes you care about.
So, when you invest in these two different sorts of bonds, how is your money spent?
How Corporations Use Money Raised Through Bond Sales
Corporations may need to raise capital for a variety of reasons. The following are a few of the most common:
- Working Capital is a term used to describe the amount of money Making money takes money, and maintaining a business can be a costly task. Corporations may need working capital for general purposes if their money is locked up in inventory, new equipment, and other assets required to keep them moving in the correct direction. Companies can issue bonds to raise cash for immediate operational requirements while pledging to repay investors later.
- Acquisitions. Companies frequently merge with one another, resulting in deals in which the total worth of all pieces exceeds the value of the original assets. Acquisitions, on the other hand, are a costly business, and companies frequently require additional capital to complete merger and acquisition deals.
- Research. Almost every publicly traded firm on the market today spends a significant amount of money on research and development. Corporations may issue bonds to fund this research in some instances.
How Municipalities Use Money Raised Through Bond Sales
The vast majority of government-issued bonds are used to fund public-sector initiatives.
When a major thoroughfare is riddled with potholes or your county’s library needs to be repaired, for example, governments frequently issue bonds to cover the costs of these projects. Governments can repay investors either through project revenue or tax revenue generated by the projects they fund.