Top Investment Tips for Buying High Yield Municipal Bonds
No matter what your age or wealth status, it is always wise to continually diversify your investment portfolio. A portion of your allocation should always be in lower risk investments. However, lower risk means lower yield as well, right? Not if you invest in high yield municipal bonds!
What are High Yield Municipal Bonds?
Municipal bonds, or “munis,” are debt instruments issued by a municipality, such as a city or county for the purposes of public works. Your sewers, streets, are bridges are in part funded from capital raised from the issuance of municipal bonds.
Municipal bonds are usually a good investment because they are most often conservatively rated at A or better by the three major rating agencies. Traditionally, the trade off for a low risk municipal bond is the lower interest rate. However, there exists a brand of municipal bond yields that are higher than the average and still provides a relatively conservative low risk rating.
Municipal bond yields at higher interest rates are offered by many states and larger cities. These types of high yield municipal bonds offer higher interest rates in exchange for a higher risk. Although the risk is higher, the default rate on high yield municipal bonds is still lower than corporate high yield bonds.
Advantages of Buying High Yield Municipal Bonds
For the average investor who wants to allocate a portion of his or her wealth into low risk bonds, buying high yield municipal bonds offer a spectrum of benefits and advantages. Here are just a few:
- More Interest – Buying high interest municipal bonds gives an investor a safer way to make more money. Though yields are not exceptional compared to prudent stock or real estate investing, municipal bond yields can still provide a sure way to make a reasonable rate of return on invested wealth.
- Tax Free Income – Buying high yield municipal bonds can also offer an added advantage of tax exemption. Most general obligation municipal bonds are issued with tax free status, meaning that all dividends and interest earned is free from federal tax, and in many cases, exempt from state tax as well.
- Low Default rates – Buying high yield municipal bonds are riskier than normal municipal bonds, but still safer than many corporate high yield bonds.
Risks of Buying High Yield Municipal Bonds
Risk still exists for any type of uninsured investment. Below are a few risks you may encounter from buying high yield municipal bonds:
- Higher default than regular municipal bonds – With higher interest comes a higher default rate. Generally, high yield municipal bonds are backed by the assets and income produced from public projects, such as toll bridges, but default rates of 8% to 44% are not uncommon for lower rated bonds.
- Rates may fluctuate – Governments have cash flow problems too. Sometimes a project is cancelled in the middle of construction, making the value of a bond specific to that project to drop on the secondary market.
- Lower yield than corporate bonds – Though buying high yield municipal bonds can bring in higher income than regular munis, corporate high yield bonds still have an even higher interest average.
Always speak with a financial advisor before buying a high yield municipal bond. However, with prudent research and strategy, a municipal bond yield may be a good choice for portfolio allocation.
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