Municipal bond investment may be an attractive option for investors in the coming year. When the Fed eventually cuts its quantitative easing stimulus plan rates will go up. That will make bonds attractive. However, with higher interest rates come higher taxes. Municipal bonds have the advantage of not carrying a Federal Tax burden. Municipal bond investment may be a good conservative version of today’s value investing.
A municipal bond is issued by a municipality. That is local government or government agencies, not the state or federal government. Issuers can include school districts, airports, utilities, and more. The bonds can be a general obligation of the municipality to repay or may be tied to an income stream such as taxes assessed at an airport or property taxed assessed to support a school district. What makes municipal bonds attractive to those in high tax brackets is that their interest is typically exempt from federal taxes and often free of state or local taxes as well. When an investor looks at the return from taxable corporate bonds or dividends on dividend stocks he or she will calculate the return on investment after taxes when comparing the investment to a municipal bond investment.
Safety of Municipal Bond Investment
Municipal bond investment is historically pretty safe. That should be said as the headlines are full of news of huge state and local deficits. However, over the last decades the default rate on municipal bonds has been less than 1% while the default rate on corporate bonds has been over 10%. Nevertheless, municipal bond investment in more than one municipality in order to balance risk is not a bad idea. A fundamental analysis of municipal bonds should include a number of specifics. Not all municipal bonds are tax exempt! A bond offering will typically come with certification by a law firm that the bonds are tax exempt and to what degree. If you as the investor do not live in the municipality or state where the bonds are issued you will probably not be eligible for a local or state tax exempt status, if it is part of the bond. Bonds are rated by agencies such as Moody’s or Standard and Poor’s. To the extent that there is a risk of default it will be wise to make sure that the bonds have an investment grade rating. As of 2008 there had never been a default on a Moody’s or Standard and Poor’s Aaa/AAA municipal bond or a Standard and Poor’s AA rated bond. Investment grade municipals in general have a historic rate of default of less than a fifth of a percent. As with all investments the investor should sit down with paper and pencil (or at the computer) and calculate the return on investment of municipal bonds versus other investments considering the relatively low level of risk involved. Depending upon if the stimulus program goes away rates may or may not rise. If so municipal bond investment may be an attractive vehicle for those soon to be paying higher taxes.