What Is It?
Municipal bonds, or “munis” for short, are debt securities issued by a state, municipality or county to finance its capital expenditures. Such expenditures might include the construction of highways, bridges or schools. Munis are bought for their favorable tax implications and are popular with people in high income tax brackets.
The major advantage to municipal bonds is that many of them are exempt from federal taxes and most are exempt from state and local taxes too, especially if you live in the state that issues the municipal bond. For example, Washington residents can get triple tax savings by buying WA municipal bonds because they pay no federal, state or local income tax on them. For this reason, munis are very popular with wealthy investors because they avoid having to claim the income for tax purposes. (To learn more about munis, see The Basics Of Municipal Bonds and Weighing The Tax Benefits Of Municipal Securities.)
There are two types of municipal debt:
1. Public Purpose – these are bonds used for government projects and are always tax exempt.
2. Private Purpose – slightly different in the sense that they are only tax exempt if it clearly says so, otherwise you are subject to the provisions placed on the bond. (This can vary widely from bond to bond.) These types of munis are called private purpose because they usually fund a project that will benefit both government and a private entity.
Objectives and Risks
For the most part, investors should buy munis for income. While capital appreciation is possible in a falling interest rate environment, this isn’t considered a primary objective of munis. When looking at muni quotes, remember that their yield is usually quite low because the tax benefits are usually priced into the bond already.
There are no substantial risks associated with buying a muni – just make sure to research the municipality from which you are purchasing it. For example, a New York muni would probably be a little more creditworthy than one from Puddle Jump, Wyoming.
How To Buy or Sell It
Municipal bonds can be purchased from almost any full-service broker and most discount brokers. Some municipalities also allow you to purchase the bonds directly through them. Minimum investment in a muni can start in the thousands of dollars.
A popular new way to invest in munis is through municipal bond funds, which pool together munis from various states and cities, allowing you to have a well-diversified portfolio while getting all the benefits that you would get purchasing the muni yourself. (For a general introduction to the world of bonds, see our Bond Basics Tutorial.)
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Source: Investopedia/WSJ
Link: http://www.investopedia.com/#axzz1ZRraBuJC
Blue’s Comments: I luv Municipal Bonds, as a great Tax Fee play and a great Dividend paid out qtry. If you search them carefuly you can find some very attractive M.B. plays paying you a nice high yield near 8 to 12 %. remember here that higher the Bond rating = lower the yield and the lower Bond rating = higher the yield %…M. Bonds are rated AAA very good but lower yield % to DDD rated has a much higher risk or less attractive Bond will give a better Yield %…There are no substantial risks associated with buying a muni – just make sure to research the municipality from which you are purchasing it. For example, a New York muni would probably be a little more creditworthy than one from Puddle Jump, Wyoming. …Another words buy in a position or Bond that may be more attractive on your selling out position if and when your ready to do so..Stay near CC or higher to BB rated Bonds, they usually have great returns..Blue
Market Risk: The underlying price of a particular bond changes in response to market conditions. When interest rates fall, newly issued bonds will pay a lower yield than existing issues, which makes the older bonds more attractive. Investors who want the higher yield may be willing to pay a premium to get it. Likewise, if interest rates rise, newly issued bonds will pay a higher yield than existing issues. Investors who buy the older issues are likely to do so only if they get it at a discount. If you buy a bond and hold it until maturity, market risk is not a factor because your principal investment will be returned in full at maturity. Should you choose to sell prior to the maturity date, your gain or loss will be dictated by market conditions, and the appropriate tax consequences for capital gains or losses will apply.
Buying Strategies
The most basic strategy for investing in municipal bonds is to purchase a bond with an attractive interest rate, or yield, and hold the bond until it matures.
Investors seeking to generate both income and capital appreciation from their bond portfolio may choose an active portfolio management approach whereby bonds are bought and sold instead of held to maturity. This approach seeks to generate income from yields and capital gains from selling at a premium.
Are Municipal Bonds Right For You?
Investing in municipal bonds can have a long-term impact on your income stream and your portfolio. To learn more about the benefits of municipal bonds, contact an investment professional or thoroughly research them yourself before investing your money.