Buying Municipal Bonds Pros and Cons
Municipal bonds are debt papers issued by local governments that include cities and counties. They are used to raise money for local projects such as streets and highways, hospitals, public housing and schools. Buying municipal bonds includes purchasing a bond in return for payments on a scheduled rate of interest. Interest is paid over a period of time that can range from just a few months to over thirty years. Once the bond matures, the investor is paid the face value of the bond. Consider buying municipal bonds that pay either from general obligation funds based on the credit of the issuer, revenue bonds paid from utilities or customers, or assessment bonds that are paid from tax assessments.
The pros to investing in mutual bonds include no federal, state or local taxes. If you purchase municipal bonds through a mutual fund or ETF you can reinvest bond income and gain greater financial growth. These types of tax free municipal bonds are generally investments in municipal development projects. The municipal bond market has lower volatility than stocks or fixed income assets. Munies are very safe avenues of revenue and do provide a better return on invested monies than treasury bonds or FCIC insured accounts. Buying municipal bonds gives an investor a highly liquid asset that is traded on the secondary market. If you need cash for investment purposes or an emergency, you can access the capital from a municipal bond easily and without a tax penalty.
You can invest in municipal bonds directly, buy municipal bonds online through a bond fund, or have your banker or broker purchase municipal bonds for you. Ensure that you know what bonds you are purchasing, the general obligations, revenue and assessments in order to determine the exact term and yields. If you are in a low tax bracket, buying municipal bonds may not be the right investment for you.
Municipal bond interest rates are dependent on the current interest rate market. If interest rates go up, municipal bonds will lose value. You purchase municipal bonds at a discount rate depending on the interest rate. If you hold the bonds until they mature, this will not be a problem, but if you have to cash out your bonds at a lower interest rate, you may lose money. A second consideration when purchasing municipal bonds for your investment packet concerns; bond yields do not beat inflation. If you are investing in municipal bonds for current income you will be okay, but if you are investing for long-term growth consider that municipal bonds are highly conservative and yields are low. The money you use in buying municipal bonds may not be worth as much in a few years as it is now. Thirdly, municipal bonds carry a risk of default and loss of capital. There is always the chance, as with any investment, that the issuing municipality could fail to pay on its obligations, go bankrupt or stop the community project. If this happens, you will lose both your primary investment as well as future interest payments. Ask your broker about insured municipal bonds that will give you piece of mind in case of severe economic downturns.