Municipal bonds, a favorite choice of US investors, are known for their low-risk nature and the high probability of repayment. By investing in these bonds, you can fund public projects that benefit your community. Issued by civic entities, these investments can mean a more attractive return compared to other forms of investment. Here, we explain how municipal bond investments work as well as investigate the potential gains you can experience by investing now.
What are municipal bonds, exactly?
Municipal bonds are a type of debt securities issued by state and local governments to finance public projects such as infrastructure, schools, and hospitals. Unlike other bonds, municipal bonds are exempt from federal taxes, making them an attractive investment for tax-conscious investors. Investors in municipal bonds typically receive periodic interest payments (known as coupons) until the bond matures, at which point they will receive the principal amount invested (face value). Municipal bonds typically have maturities of 10-30 years.
What types of municipal bonds are available?
Municipal bonds are debt securities issued by state and local governments to finance public projects such as road construction, school buildings, hospitals, and bridges. They are typically backed by the full faith and credit of the issuer, which means that the issuer is obligated to use its revenues to repay bondholders.
There are two main types of municipal bonds: general obligation bonds and revenue bonds. General obligation bonds are issued by the government entity itself and are typically supported by property taxes or other dedicated revenues. Revenue bonds, on the other hand, are issued by special purpose entities created for a specific project, and they are repaid with the revenues generated by that project (e.g., from user fees or tolls).
Municipal bonds can be further classified into short-term and long-term bonds, depending on their maturity date. Short-term municipal bonds have maturities of one year or less, while long-term municipal bonds have maturities of more than one year. Long-term municipal bonds typically have lower interest rates than short-term municipal bonds because investors are willing to tie up their money for a longer period of time in exchange for a higher rate of return.
Municipal bondholders also have the option to receive interest payments either annually or semi-annually. Annual interest payments are more common for shorter-term municipal bonds, while semi-annual interest payments are more common for longer-term municipal bonds.
So why invest?
A major benefit of investing in this type of bond is its tax-free status. As it is a loan for the city to do public-facing work, the interest accrual rate isn’t taxable. This means that you stand to gain more from your overall investment than you would otherwise be eligible to.
Municipal bonds also offer the following benefits:
Municipal bonds are often viewed as a safe investment because the full faith and credit of the issuing municipality backs them. This means that if the issuing municipality defaults on its obligations, investors may still be able to recoup their investment through tax revenue or other sources of income.
Municipal bonds also offer a number of tax advantages. Interest earned on most municipal bonds is exempt from federal income taxes, and may also be exempt from state and local taxes if the bonds are issued in your state of residence. This can make municipal bonds an attractive investment for those who are in high tax brackets.
Another benefit of investing in municipal bonds is that they tend to be much less volatile than other types of investments, such as stocks and mutual funds. This means that your investment is less likely to lose value suddenly, which can help you preserve your capital.
Finally, municipal bonds can provide a stead source of income. Because they typically have maturities of 10 years or more, you can plan on receiving regular interest payments for many years to come. This can provide some peace of mind for investors who are looking for stability in their portfolio.
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