x

Why Invest in Municipal Bonds?

Tax Free Advantage

For many investors, the main advantage of municipal bonds over other comparable fixed-income investments, such as corporate bonds or bank CDs is that interest earned from municipal bonds is exempt from federal income taxes, and, depending on the residence of the bondholder, may also be free of state and local taxes.

For example, an investor in the top federal tax bracket in 2019 would have to earn 6.35% on a comparable taxable investment to match the (in your pocket) tax-free rate of 4.00% from a tax-free municipal bond.  For investors living in states with high state income tax rates, owning a home state-issued municipal bond may make that tax free advantage even greater.

But not all municipal bonds are 100% tax-free. There are also municipal bonds that because of specific tax law considerations may pay income that is taxable or income that is subject to the AMT for some taxpayers. In addition, some states may apply state taxes to the income from municipal bonds.  It is important to be aware of the tax status of any investment, including municipal bonds.

Potential Safety of Principal and Regular Predictable Income

If you are an investor who is concerned with the return of your investment and not just the return on your investment, then municipal bonds have historically offered a very good track record. In March of 2012, Moody’s published research that showed that rated investment-grade municipal bonds had an average cumulative 10-year default rate of just 0.10% between 1970 and 2017.* That means while there is some risk of principal loss, investing in rated investment-grade municipal bonds can potentially be a cornerstone for safety of your principal.

There are several different types of credit structures that back the repayment of municipal bond’s interest and principal.

General Obligation bonds (G.O.) are backed by the full faith and credit of the taxing power of the issuing city, county or state.  G.O. bonds have been viewed historically as the type of bonds that offer the greatest security and stability in the fixed income sector.

Revenue bonds are backed by the operations and revenue of municipal facilities such as airports, toll roads, and water & sewer systems.

In addition to the credit backing of GO and Revenue bonds, for potential additional protection, many municipal issues include credit enhancements from third-party insurers, special government appropriations or even the “Double Barrel” protection of bonds backed by pledged revenue and G.O. taxing power.

All municipal bonds, if held to maturity or redeemed at an early call date are designed to pay 100% of face value, no matter what happens to their market value during the time you own the bonds. Plus, as long as you own the bonds the, amount of interest paid never changes, regardless of what happens to the interest rate market or the economy. If income is still the goal, when a bond matures or is redeemed prior to maturity, investors may reinvest that principal at whatever the current market rate may be, earning either more or less income from the newly purchased bond.

Of course, the past results of municipal bond investments are no guarantee of future performance. But your Hennion & Walsh financial representative will help you understand the risks involved and assist you in your investment decision making.

Marketability/Liquidity

Holders of municipal bonds can sell their bonds in the multi-trillion dollar municipal securities secondary market through one of the many banks and securities dealer firms which are registered to buy and sell municipal securities. Municipal bonds are sold in the over-the-counter market.  If you sell your bonds prior to maturity, you will receive the current market price, which may be more or less than the original cost.

Risks

When investing in municipal bonds, investors should principally be aware of these types of risk.

Market Risk.

While the interest payment cannot be changed during the life of a bond (unless it is a variable-rate security), the market price of a security fluctuates as market conditions change. If you sell
your municipal bonds prior to maturity, you will receive the current market price, which may
be more or less than the original cost.

Credit / Default Risk.

If a local government declares bankruptcy, it can default on its bond obligations, which may
cause bondholders to lose part or all of the principal they invested. Although defaults have
occurred at an overall rate of less than 1% since World War II, we encourage investors to work
with a municipal bond expert to carefully choose the municipal bonds they plan to invest in.
This means that they should also understand the underlying credit ratings and insurance status
of municipal bond issues.

Reinvestment Risk.

The risk that future coupons from a bond will not be reinvested at the prevailing interest rate
when the bond was initially purchased. Reinvestment risk is more likely when interest rates are
declining. Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the
premise that all future coupon payments will be reinvested at the interest rate in effect when the
bond was first purchased.

Interest Rate Risk.

As with other fixed-income securities, municipal bond prices fluctuate in response to changing
interest rates. When interest rates fall, new issues come to market with lower yields than older
securities, making the older securities worth more. Conversely, if interest rates rise, new issues
come to market with higher yields, making older issues less attractive.

*Source: Moody’s Investor Service, July 31, 2018 “U.S. Municipal Bond Defaults and Recoveries, 1970-2017.”