Municipal bonds can be a suitable choice if you're searching for a secure, low-risk approach to safeguard your wealth while earning a consistent income. But before deciding whether or not to invest in them, you need to conduct some study.
Muni bonds provide several advantages, including significant tax savings and diversification. However, they also come with dangers, such as interest rates and call risk.
If you hold municipal bonds, you presumably already know that interest rates impact yields and prices. Investors often sell older bonds with lower yields in favor of newer ones with greater yields as interest rates rise.
But things have been different this year. Municipal bonds have suffered as a result of the Fed's increase in interest rates.
The Bloomberg Municipal Bond Index (BBB), while losing 12.5% in the first quarter of this year, continues to outperform Treasury securities. Additionally, muni bonds provide an attractive risk/return potential with tax-equivalent yields close to 7%.
This year, various variables, including the Federal Reserve's policy on rate hikes and a potential recession, are expected to influence returns. Traditional muni bond drivers, including a stable tax environment, a small supply, and solid credit fundamentals, still seem to work in favor.
For buyers of municipal bonds, taxes are a top priority. This is because various bond kinds may be taxed or tax-free based on your state of residence and personal financial circumstances.
Most municipal bonds are exempt from federal and, in certain cases, state and local income taxes. However, if you are subject to the alternative minimum tax, the interest on certain private-activity bonds—such as those used to finance sports arenas or airport terminals—is taxed.
As a result, fluctuations in tax rates have an impact on muni prices. If interest rates are lower, new issuing will probably need to pay a higher interest rate, which would likely result in a price fall for existing municipal bonds. This will lower the cost of current munis for rich investors, which should increase demand.
A credit enhancement known as bond insurance ensures that interest and principal on a bond will be paid on time and in full, even in the event of issuer failure. Monoline insurers often provide it to bond issuers that satisfy certain credit requirements.
Depending on the underlying credit quality and market circumstances at the time of the bond sale, insured bonds often result in considerable interest expense savings for the issuer. It's crucial to remember that not all munis are covered by insurance.
The once-destroyed municipal-bond insurance market has recently recovered, and insured munis now make up roughly 10% of all new munis. The upfront protection provided by insurers is a pledge to compensate investors if a municipal debt is downgraded or defaults. Several large, reputable issuers are now using this credit enhancement to ease market concerns. Most of the recently issued bonds are insured by Assured Guaranty and Build America Mutual.
Municipal bonds are typically tax-exempt and are issued by governmental bodies. They may be a better choice for investors who wish to maintain capital rather than grow it since they are often less risky than equities.
Municipal bonds are traded in an over-the-counter market. Therefore their prices fluctuate from dealer to dealer. Bond brokers, or BBs, serve as intermediaries between dealers and investors by buying and selling bonds on their behalf.
The BBs are anonymous but still have to abide by certain restrictions. They must ensure that the bonds are appropriate for their clients and inform them of any relevant information regarding the bond.
They must also be able to make money when they sell the bond. They must also declare any control they may have over the bond issuer.
Investors need to know this information since it helps in their decision-making about the bonds they buy. It may also assist them in avoiding expensive mistakes. It may also assist them in determining if they need to keep the bond until it matures or sell it earlier.