How You Can Build Your Portfolio by Investing in Municipal Bonds
As an intelligent part of a diversified investment portfolio, municipal bonds provide you with consistent, low-risk returns. Investing in municipal bonds, also known as “munis,” provides you with a tax-free income stream, as well as a place to preserve your capital in a tax-exempt instrument.
Of course, a municipal bond investment is not a way to generate annual double digit returns, but they are a key part of a sound, diversified investment strategy.
What are Municipal Bonds?
Municipal bonds are a debt instrument issued by government agencies, such as cities, counties, or state governments. If you are investing in municipal bonds, they typically fall under one of two categories:
- General Obligation Bonds (GO Bonds) – These bonds are backed by the ability of the issuing agency to tax its constituents. GO Bonds are mainly used to help finance public works, such as new sewers, new roads, or even a new baseball stadium.
- Revenue Bonds – Revenue bonds are issued by governing agencies to raise money or create revenue for sanctioned entities, such as hospitals or public zoos. These bonds help build infrastructure and are also backed by the taxability of the issuing government.
What Do Municipal Bond Investments Offer as an Investment Strategy?
When you consider municipal bond investment, there are a number of other factors to evaluate, including tax advantages, income stream desires, and interest yield. Of course, a high-interest yield bond is usually the most desirable, and you also want to opt for a muni with a high yield and good credit rating.
Municipal bond investment may offer a yield at maturity or stream of income option, depending on the issuing agency. In many cases, bond issuers will make regular interest payments on a muni, providing you with a nice stream of income. However, others may wait to pay the full interest yield at maturity.
Municipal bond investment also requires you to consider the tax advantages. Municipal bonds may be issued as a tax-free or a taxable instrument. Depending on your income bracket, you can save money on taxes with municipal bond investment. Check with your financial advisor for which is best for you.
Investing Municipal Bonds: Risk Factors
Investing in municipal bonds doesn’t come without financial risk. Each government bond is rated by a professional rating agency, such as Standard & Poor’s or Moody’s. The rating agency will research the financial strength of the issuing government to repay a bond, as well as the strength of the local economics. A muni issued by a thriving and growing community will have a much better rating than one from a city in economic decline and high unemployment.
To be as safe as possible with your municipal bond investment, consider investing in a government that has a good history of bond repayment, has a growing population, and a diverse economy.
Municipal bond investment is a practiced and low-risk investment strategy. Though yields are not the best compared to all of your financial instrument options, you can generate a good and secure stream of income from municipal bond investment, as well as enjoy tax advantages from government issued bonds. However, always be sure to check the credit rating of the government bond before investing to ensure that you have a low-risk option.
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