Advantages of Municipal Bonds ETF vs Regular Broker
To better understand the advantages of municipal bonds ETF or exchange traded funds vs regular broker bonds terms need to be defined. Bond ETFs consists of muni bonds or local government bonds. Local governments issue debt bonds to raise capital for towns, cities, and counties, to help with urban development, education, utilities or infrastructure. You loan or invest your money to pay for a specific project through exchange traded funds or by regular broker bonds.
There are two customary types of municipal bonds which are titled general obligation and revenue bonds. Bonds classified as general obligation bonds are supported by the taxing power of the issuing agency and interest and final principal amounts are paid to investors through normal taxes. Revenue bonds are backed by the specific project. Investors are paid back through charges, fees and purchases. Most municipal bonds ETFs are insured which guarantees that if the initial bond issuer defaults, the bond insurance company will continue paying the interest. These types of bonds have lower interest rates and carry less risk.
Municipal bond interest rates depend on market conditions and the best municipal bonds depend on the rate of return, the security and the availability. Floating rates municipal bonds are good for long-term investors and can bought and sold without the threat of losing principal. Put bonds can be sold back to the issuer at specified dates before bond maturity. Generally the investor and issuer determine the value of the bond at a specific date. Zero coupon public bonds have no interest payments due until the final maturity date. These are good for long term investing. Taxable municipal bonds are those bonds that do not have a clear benefit to the general public. These include sports facilities, funding city pension plans, art galleries, or general meeting areas. High yield municipal bonds are also considered as junk, non-investment grade, and speculative grade bonds. These bonds historically have a high risk of default, but do pay higher yields than higher quality bonds
Advantages of municipal bonds ETFs are the tax free benefits. Make sure you are purchasing bonds that are actually tax free versus bonds that fall under the alternative minimum tax amount. Munis tend to be low risk since local governments generally do not default on debt responsibilities. Research the various municipal bond ETFs to make sure your find the right fund for your investment portfolios. You need to check out the bond’s reaction to various market conditions. Do be aware that there is low risk with Munis which equates to low rates of return.
Municipal bonds ETFs also allow investors the opportunities to trade bonds or work the bond markets through their stock market trading accounts. However, the distinct disadvantages to municipal bonds ETFs versus regular bonds are the loss of mimicking underlying assets. Also, ETFs do not have specific maturity dates. ETFs are based on the average value of a bond that is following a market, whereas a bond can be redeemed at face value as it nears the end of its lifetime. Holding a bond carries low risk and carrying a bond ETF will cause the ETF to either outperform or underperform the actual bonds. You will also have management fees with bond ETFs. If the bond ETF is held for some time, the management fees can be quite high. It can be better in the long run to purchase high yield municipal bonds directly through a broker rather than using an ETF format.