FREQUENTLY ASKED QUESTIONS
New to municipal bonds? Looking to understand the fundamentals of the municipal bond market? You are in the right place.
What are municipal bonds?
Also referred to as munis, these are debt obligations that are issued by state and local governments, as well as authorities such as public utilities, school districts, and other agencies to fund public projects such as the repair or construction of public roads, hospitals, airports, and more.
Buying a municipal bond implies that you are lending money to the local government or entity that issued the bond. In return, the entity promises to pay you a certain amount of interest – typically paid twice a year – in addition to returning your principal on a set maturity date.
What are the types of municipal bonds?
There are generally two types of municipal bonds, and they include General Obligation Bonds and Revenue Bonds.
General Obligation Bonds
These refer to a type of muni bond where the issuing entity promises repayment of the bond and pledge their full faith and credit to the bondholder. The implication is that the issuer of the bond can use their taxation power to pay back the money they owe.
Thus, if the entity encounters a problem that restricts their ability to pay back its issued bonds, it will typically raise taxes in order to earn the money required to pay back those bonds. Also, they can manage their budget accordingly, temporarily reducing services to allocate more of their revenue to bond payments. GO bonds are characteristically issued by states, cities, towns, or school districts.
This refers to a type of bond which is repaid using revenue generated by the projects which the bond helped fund. The entities that issue these bonds are typically utility systems, thruway systems, universities, hospitals, and governments that lease properties for police, fire, and legislative/administrative entities.
What is a callable bond?
A callable bond, also known as a redeemable bond, is a type of bond that the issuer can redeem before it matures. The nature of bonds is that they usually have a maturity date, which is typically long-term (typically 11-30 years).
With a callable bond, the bond issuer may call back its bonds and reissue them at a lower interest rate. The benefit of a callable bond is that it can earn a higher yield than non-callable bonds. If interest rates fall below the bond’s coupon, the bond issuer has the ability to redeem those bonds so they can refinance the bond at lower interest rates. Click here to see examples of callable bonds that exhibit relative value.
Are municipal bonds safe?
Municipal bonds have historically had a low default rate. This is because a large swath of munis are secured by income, property and sales taxes or dedicated revenue streams from essential service utility bonds. Moreover, municipal bonds have advantages not typically found in corporate bonds such as an ability to raise taxes or manage their budget in a way as to maintain their abilities to make timely payments of principal and interest.
Nonetheless, investors need to understand that municipal bonds can differ significantly. Even though most of these bonds tend to share the same objectives, the states, cities or entities issuing these bonds can vary significantly in terms of economic robustness. Thus, investors that are looking to add municipal bonds into their investment portfolios must have a thorough understanding of the entities responsible for servicing their bond interest payments in addition to the economic stature of the issuing entity.
As such, some of the most important things to consider when looking to invest in GO municipal bonds include an issuer with a reasonable population size, an economy which is not reliant on one industry or sector, the financial health of the government and a proven track record of making prompt payments on previous municipal bonds. One must consider similar issues for revenue bonds including population size and utilization of the issuer’s services, economic health of the geographic area, the entity’s financial health, and the importance of the issuer’s services to the user base.
When it comes to overall safety, A – AAA rated municipal bonds are considered some of the safest investments that an investor can add to their portfolio.
What are the advantages of municipal bonds?
1 – Tax-free from federal income taxes
Municipal bonds offer a way for individuals in higher tax brackets or those seeking to have a tax-exempt income stream for retirement. The investor will enjoy healthy income streams that are tax-exempt and can help preserve principal net of inflation.
2 – Tax-free from State and Local Taxes.
In most states, when you invest in municipal bond issued within your state of residency, the income earned will be exempt from state and local taxes.
3 – Compound Income/Growth that is Tax-Advantaged
When your investments are exempt from taxes, they are able to compound without tax-drag which can help grow your wealth.
4 – Lower Volatility
The volatility of stocks is not one of their most admirable qualities. Thus, adding to investments that showcase lower volatility while still providing you with tax advantages is one of the best ways to add safety and improved income to your portfolio.
5 – High Liquidity Level
Municipal bonds feature high liquidity and can be traded on secondary markets. This implies that if you are ever in need of cash for an expense, vacation, of gift, you can quickly access your capital.
What is the difference between tax-free bonds and taxable municipal bonds?
Tax-exempt municipal bonds are typically not subject to federal, state, or local taxes, while taxable municipal bonds are subject to federal taxes, though can be tax exempt from state and local taxes if you buy those issued within your state of residency. They are backed by the same types of repayment sources as exempt municipal bonds. These include:
- State and local governments
- Cities and towns
- School Districts and Colleges
- Transportation Systems and more
The choice between tax free and taxable municipals requires some thought. Tax-free municipal bonds make sense for high-tax bracket investors with money in taxable accounts. Muni bonds are an excellent way of investing in low-risk assets while having the benefits of tax exemption. Taxable municipal bonds make sense for investors in lower tax brackets with money in taxable accounts and investors with IRAs, pensions, and any other tax-deferred accounts. Click here to learn more about taxable municipal bonds.
What Is The Difference Between Taxable Municipal Bonds and Corporate Bonds?
Taxable municipal bonds are appealing for their yield, income, and credit strength compared to corporate bonds. Many investors are unaware of this asset class which is unfortunate given it is compelling and they might benefit from it. Did you know that BBB munis have the same level of credit strength as AAA corporates according to a recent Moody’s study? Did you also know that BBB taxable munis yield more than AAA corporate bonds even though the credit risk is about equal? This risk-adjusted yield improvement is onf of the primary appealing benefits of taxable municipal bonds compared to corporate bonds. Click here to learn more about taxable municipal bonds.
Should I Invest in Taxable Municipal Bonds?
If you are investing in corporate bond mutual funds or ETFs in your brokerage accounts or tax-deferred accounts (IRA’s, pensions, etc), we suggest you consider taxable municipal bonds as a replacement or a complement. This asset class provides stronger risk-adjusted returns (as measured by yield for unit of credit risk), high coupons (4-7% on average), and our ability to consistently find strong yield value in addition to the above yield levels is possible through our on-going process of bidding bonds at below market values. You may pick up more yield, earn higher coupon streams, and improve the overall credit strength of your portfolio with taxable munis. Click here to learn more about taxable municipal bonds.
Are Municipal Bonds Better Than Mutual Funds and ETFs?
Individual municipal bond portfolios appear to be a better approach. They can provide important advantages within the key measures of yield, income, and interest rate management. A significant source of individual bonds’ additional yield originates from the secondary municipal bond market’s inefficiency. When attractively positioned bonds are identified by our team of portfolio managers and traders, we aim to extract additional value by bidding on odd-lot pieces. While nearly every municipal bond fund and ETF participates in the secondary market, their enormous asset levels preclude them from deriving nearly as much value for their portfolios as compared to our clients’ relatively smaller portfolios. This is one of the few areas in financial markets where a smaller investor has a larger advantage. Other advantages include a lack of reliance on pricey new deals, our ability to customize mandates for each clients’ state tax exemption, and our efforts to identify attractive relative values in structures that a mutual fund or ETF may not be permitted to hold buy because they are heavily benchmark driven. We are client-driven. Click here to learn more about the advantages of individual municipal bonds versus mutual funds and ETFs.
What Is The Current Interest Rate of Municipal Bonds?
Municipal bonds interest rates vary depending on investor demand, bond supply, treasury yields, and tax policy. Thus, at any given moment, the municipal bond interest rates can vary. Our goal is to point our clients toward the most attractive portions of the bond market. We extensively screen the entire market for opportunities and target select corners of the market where we identify relative value. To view some bonds that we feel are compelling values click here.
What are some of the Best Municipal Bonds You Could Buy Today?
The best bonds are based upon your individual circumstances: your state of residency, your tax bracket, your investment goals, your growth target, and more. Working with experienced municipal bond professionals is the best path to identifying the best bonds for you. Click here for examples of municipal bonds that we like.
How to Buy Municipal Bonds
The municipal bond market is about $3.8 trillion dollars in size spread across thousands of issuers. The market is vast and in our opinion, many of these bonds are unappealing because they are suitable for banks, insurance companies, and institutions with very long time horizons or specific hedging requirements.
We believe individual investors are best served by partnering with advisors that can help you sift through the market and bring to the surface investments that are strong relative values and suitable for your goals.
Our team at Moors & Cabot can help you with your investment goals. A knowledgeable bond professional can also make a large improvement in your execution levels.
Municipal bonds are a good way of generating steady income. Nonetheless, you will need to weigh the pros and cons of this option before you add it to your portfolio to ensure it suits your needs.
STATEMENT OF DISCLOSURE
Past Performance is not indicative of future results. Moors & Cabot does not provide tax advice. Please consult a tax professional. The bond market can be volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties.
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