A municipal bond issued by cities, local governments, or their agencies in California is known as a California municipal bond. Roads, schools, parks, public utilities, housing, publicly owned airports and seaports, levees, public facilities, and other critical building and infrastructure projects in California are funded by municipal bonds.
California municipal bonds can be general obligations of the issuer or revenue-secured obligations. They can be short or long term, with maturities ranging from 1 to 30 years.
What is the purpose of California bonds?
Bonds issued by the state are known as general obligation bonds “California’s “full faith and credit” “The term “full faith and credit” refers to the issuer’s promise to repay the bonds with all legally available funds. Local entities, such as schools, frequently issue GO bonds that are solely repaid from the issuer’s property taxes.
Are municipal bonds in California a good investment?
Municipal bonds are an excellent method to keep your money safe while earning interest. The majority of them are tax-free at the federal level, and several are also tax-free at the state and local levels. Munis are frequently treated as a unique asset class, therefore understanding the fundamentals of muni bonds is essential.
How safe are California bonds?
- 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.
How are debts in California repaid?
These bonds are guaranteed by an issuer’s general revenues, which include taxes. They do not, however, have a specific tax pledged to repay them, unlike dedicated tax GOs. Instead, bondholders are compensated from general revenues, which, if insufficient to satisfy debt service, force the issuer to raise taxes.
Is it possible to lose money in a bond?
- Bonds are generally advertised as being less risky than stocks, which they are for the most part, but that doesn’t mean you can’t lose money if you purchase them.
- When interest rates rise, the issuer experiences a negative credit event, or market liquidity dries up, bond prices fall.
- Bond gains can also be eroded by inflation, taxes, and regulatory changes.
- Bond mutual funds can help diversify a portfolio, but they have their own set of risks, costs, and issues.
What are the interest rates on California bonds?
However, there are several bond funds that invest in these high-quality California bonds and provide substantially greater yieldsup to 5.4 percent! And don’t forget, it’s all tax-free. If you invest $100,000 in any of these funds, you’ll receive $450 in tax-free income each month.
High-yielding closed-end funds (CEFs) are your best bets, with some of the greatest annualized returns available.
On the negative, because muni-bond CEFs are becoming more popular among retail investors, many of them are becoming overbought and riskier by the day.
Take, for example, the PIMCO CA Municipal Income III Fund (PZC), which I wrote about a month and a half ago, highlighting that its price drop was unavoidable due to its excessively high premium to its net asset value (NAV, or the value of its underlying assets).
That kind of price drop isn’t what you want in an asset like a municipal bond, which is supposed to be safe.
Fortunately, there are eight funds on the market that provide more stable income and higher returns than this one.
While PZC has delivered an annual return of 4.4 percent while paying a 4.9 percent dividend over the last decade, there are some funds that have delivered better returns and pay similar or even higher dividends:
So, how come these funds outperform PZC, and why aren’t investors opting for them instead of PIMCO?
To appreciate why PIMCO’s California bond funds (PZC is only one of many the company offers) are a lousy deal, you must first understand PIMCO.
PIMCO stands for Pacific Investment Management Company and was founded by UCLA alum Bill Gross in Newport Beach, California. The firm has grown to manage roughly $1 trillion in assets for investors over the last few decades.
PIMCO has undertaken an intensive marketing campaign throughout California, which is one of the main reasons for this. Because of their convenient headquarters in Newport Beach and their relationships with California’s ultra-wealthy, PIMCO has an easy market in which to offer its products in its home state. This also means that its funds are frequently overbought and provide little additional value.
Meanwhile, other management businesses have similar or superior long-term success in their funds, but they can’t compete with PIMCO when it comes to marketing to investors because they’re not situated in California.
As a result, these funds are frequently undervalued in comparison to their true asset worth. If you bought PIMCO’s PZC, for example, you’d have to pay $1.10 for $1.00 of assets, whereas the Eaton Vance CA Municipal Income Fund (CEV) costs just $0.89!
What’s the bottom line? There are a slew of muni-bond CEFs out there that promise you tax-free income and high gains.
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.
Municipal bonds make sense at what tax rate?
This is where you decide whether or not a muni is right for you. Divide its return, say 1.20 percent, by your reciprocal rate of 68 percent to get 1.76 percent. That’s your tax-equivalent yieldor, to put it another way, your muni tipping point. It means that, assuming all other factors such as maturity and rating are identical, a taxable bond must yield more than 1.76 percent to make more sense for someone in your tax bracket than a 1.20 percent tax-exempt bond.
Is it true that you pay taxes on I bonds?
- State and municipal taxes are not levied on Series I savings bonds. You won’t have to pay state or local taxes on the interest income you earn if you invest in Series I savings bonds. That means you’ll have more money in your pocket at the end of the year than if you owned a traditional bond.
- Federal taxes apply to Series I savings bonds. The interest income you generate while holding I bonds will be taxed by the federal government. This is because they are a “zero-coupon” bond, which means that you won’t receive regular checks in the mail; instead, the interest you earn is added back to the bond’s value, and you’ll earn interest on your interest.