There are many ways to describe the Golden Gate Bridge. Here's one that might not spring to mind: another municipal bond success story.
Who'd have thought the first bond deal in 1812 (to pay for the digging of a New York canal) would herald the transformation of America's infrastructure.
Ever since, investors have financed vital projects: from hospitals and schools that serve local communities, to iconic projects famous the world over.
What are Municipal (Muni) Bonds?
If your primary investing objective is to preserve capital while generating a tax-free income stream, muni bonds are worth considering. Muni bonds are debt obligations issued by government entities i.e. States and Counties. When you buy a muni bond, you are loaning money to an issuer in exchange for a set number of interest payments over a predetermined period. At the end of that period, the bond reaches its maturity date, and the full amount of your original investment is returned to you. In general, muni bonds fall into one of two categories- general obligation or revenue bonds. However, within these categories, a municipal bond can be structured in different ways, with each variation offering different benefits, risks, and tax treatments. While most investors think of muni bonds as tax-exempt investments, this may not always be the case, as there are instances where the income generated by a municipal bond may be taxable.
Benefits and risks of municipal bonds
On the whole, muni bonds have a low default rate. Between 1970 and 2015, there were only 99 muni bond defaults. Of these, only nine general obligation bonds defaulted; not a single muni bond with the highest credit rating defaulted. Muni bonds have 50 to 100 times less likely to default than corporate bonds. That said, muni bonds still are not risk-free. In recent years, some governments have defaulted on their municipal bonds including Detroit in 2013 and Puerto Rico in 2016. Muni bonds generally offer lower interest rates than corporate bonds- though, as with treasury bonds, that interest is tax-free. (Keep in mind, however, that the tax-free benefits of muni bonds only apply to interest payments-- not capital gains. If you sell a bond for more than you paid for, those gains are still taxable.)
Who buys muni bonds?
- About 72% of the bonds are owned by individuals directly or through mutual funds.
- Three-fifths by investors over the age of 65.
- Roughly 40% of muni bond interest is paid to households with an income of less than $200,000.
- About 25% of bonds are owned by businesses, primarily property and casualty and life insurance companies, but also banks.
Investors seeking to generate tax-free income from a stable investment with a three to five-year and longer time horizon may want to take a look at municipal bonds. Expect muni bonds and the talk of infrastructure to be in the news as the new Biden Administration is expected to positively impact the municipal bond market. In addition, investor anticipation of the Biden Administration pushing taxes higher (more likely a 2022 event) increases the value of the tax exemption and municipal bond demand.
~ Robert Bullock
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply