Buying Individual Municipal Bonds
Municipal bonds are a great investment for risk-averse investors. When state or local governments need to raise money, they will issue debt obligations called municipal bonds or "muni's". When you buy such a bond you are loaning money to a government in exchange for interest paid to you over the life of the bond. When the bond matures at the end of its term, the full amount you invested is returned to you. Typically muni's are purchased through brokers. [1]XResearch source
buying individual municipal bonds
When comparing different types of bonds, municipal bonds are considered a higher-risk investment than Treasury bonds. You might think munis are unlikely to default because governments issue them, but that's not always the case, and some municipalities have defaulted on their obligations in the past. It's important to understand these investments are not risk-free, and you should always review the bond's rating before investing.
Credit rating agencies such as Standard & Poor's (S&P), Moody's and Fitch's rate municipal bonds to help investors assess the creditworthiness of the issuer and the likelihood of default. A higher credit rating generally indicates a lower risk of default and a lower likelihood that the issuer will be unable to make interest and principal payments.
Municipal bond exchange-traded funds (ETFs): Municipal bond ETFs can offer you another way to invest in a group of funds. They hold a basket of municipal bonds and trade on stock exchanges like individual stocks.
State income taxes: You may have to pay state income taxes, particularly if you buy municipal bonds from a state where you do not reside. The interest may be subject to state and local taxes in this case.
Social Security income taxable amount: If you receive Social Security, your muni bond interest will count toward your adjusted gross income, possibly increasing your Social Security income taxable amount. If you receive Social Security benefits, a portion of your benefits may become taxable if your combined income, including taxable interest from municipal bonds, exceeds certain thresholds.
The average rate of return on a municipal bond varies depending on several factors, including the issuer's credit quality, the bond's term and current market conditions. Municipal bonds generally offer lower yields compared to taxable bonds due to their tax-free status.
Bond term: A municipal bond term refers to the length of time until the bond reaches its maturity date. The issuer must repay the face value of the bond to you, the bondholder, upon the maturity date. The term can range from a few months (short-term bonds) to 30 years or more (long-term bonds).
Most municipal bonds occur in a minimum denomination of $5,000. To target institutional investors, municipal bonds sometimes come in larger amounts, such as $25,000 or $100,000. Municipal bonds also may be issued in a minimum denomination of $1,000 to attract local investors.
Tax exemptions: Earnings on municipal bonds are tax-exempt at the federal level and are often exempt at state or local levels. Of course, it's critical to check with your tax advisor to understand the tax consequences of any investment. But investing in munis could be a way to generate tax-free income.
Price volatility: Tolerating price volatility as it occurs may be easier said than done. Be sure to choose a municipal bond investment consistent with your risk tolerance. Increased time-to-maturity, higher coupons, longer duration, illiquidity and bonds trading at a discount can increase the volatility of bond prices.
Whether you invest in munis as part of a socially responsible investing (SRI) strategy or to balance out your portfolio, you can buy municipal bonds on the primary or secondary market. But where to buy municipal bonds? However, it's typically less common to invest in the primary market. You'll likely buy municipal bonds from a bond dealer, broker or bank like Ally Invest.
When you invest in a bond mutual fund or bond ETF, your portfolio has exposure to all the individual bonds held within the fund. Both bond mutual funds and ETFs can provide diversification to your bond allocation. Because bond ETFs trade on an exchange, like stocks, they might also offer a more accessible way to invest in bonds than investing directly in the bond market. Remember that because mutual funds and some ETFs are actively managed, these investments typically come with associated fees.
When you're ready to invest in municipal bonds, consider your investment time horizon (the amount of time you have to invest), your investment objectives, asset allocation, risk tolerance and available capital. Choose a bond with a maturity date that coincides with when you expect to need the money.
Most investors are familiar with tax-free municipal bonds and the bulk of the $3.8 trillion muni bond market falls within this category. Here, state governments and agencies as well as local municipalities issue bonds to fund their activities. These bonds have been a portfolio staple for decades thanks to their tax advantages. This is especially true for investors in higher tax brackets.
So, why would anyone want to consider taxable munis for their portfolios? After all, the main appeal of municipal bonds is the fact that they offer tax free income, right? It turns out the tax advantages may not be as great for many investors.
Perhaps the only problem comes down to getting your hands on taxable munis. Already, buying individual muni bonds is hard. Given the small size of the taxable muni segment, buying individual issues is pretty much impossible. However, there are numerous funds that offer exposure.
The JPM Investment Grade Index (JULI) provides performance comparisons and valuation metrics across a carefully defined universe of investment grade corporate bonds, tracking individual issuers, sectors and sub-sectors by their various ratings and maturities.
Taxable bond issuance surged again in 2019. From August 2019 to November 2020, between 15% and 40% of municipal bonds issued each month were taxable. In October 2020, borrowers issued $45.2 billion in tax-exempt municipal bonds and $25.1 billion in taxable municipal bonds. (In comparison, corporations issued $152.9 billion in bonds in the same period.)
One big reason is a provision of the 2017 Tax Cuts and Jobs Act, which prohibited the use of tax-exempt bonds for advanced refunding transactions, a refinancing maneuver we describe below. Previously, when interest rates declined, issuers of tax-exempt municipal bonds could issue a second tax-exempt bond to refinance their debt. Now, entities that want to use advanced refunding must issue taxable bonds.
Taxable municipal bonds also may be more attractive to people in lower tax brackets, for whom the tax exemption is less valuable. Assuming a 5% state income tax, someone in the 22% tax bracket will keep 83% of the interest on a taxable municipal bond; someone in the 35% tax bracket who would also owe state income taxes and an additional 3.8% Net Investment Income Tax (the Obamacare/ACA tax) will keep only 56% of the interest. Depending on current interest rates, someone in a lower income bracket might find the (after-tax) yield on taxable municipal bonds appealing. 041b061a72