If you’re investing for retirement or seeking a reliable income stream, muni bonds provide several advantages that can help you meet your investment objectives.
Tax-exempt income is one of the most appealing features. Interest earned usually avoids federal and state taxes, making them ideal for investors in higher tax brackets.
1. Tax-Free Income
Tax-exempt income is one of the primary reasons investors choose municipal bonds over other investments, particularly for retirees who desire a steady source of interest from their portfolio.
Investing in municipal bonds can be done either directly through individual bonds or ETFs that invest in municipal bond funds. ETFs tend to offer higher yields than individual bonds, however they may also have greater volatility.
Generally, tax-free bonds offer the same after-tax returns as taxable bonds with similar maturity dates. However, if your tax bracket is higher and there is more taxable income in your retirement account than what’s left over after taxes, corporate bonds could be a better investment choice instead.
2. Stable Returns
Muni bonds offer stable returns that are often more appealing than high-yield bonds. They tend to pay higher yields than Treasury securities, making them an attractive option for investors looking to protect capital or generate tax-exempt income streams.
Muni bonds are typically issued by state, county and city governments due to their usually strong financial positions which allow them to print money if necessary to service debt payments.
Municipal bond prices can also fluctuate due to changes in interest rates and market expectations for future rates, creating a wide range of yields and prices in the secondary market.
Municipals historically outperform other fixed income asset classes, such as Treasuries and investment grade corporate bonds. Although the current cycle of Fed interest rate hikes has had an impact on performance, state and local government finances remain strong due to high tax receipts and rising property values which have contributed to improving credit conditions.
3. Diversification
Muni bonds tend to have low correlations with other asset classes, making them an effective diversifier.
Credit Risk: The rating of a municipal bond is an important factor when determining its value. Issuers with high ratings tend to pay back principal and interest on time. Nonetheless, just because a bond has a good rating doesn’t guarantee its value won’t decrease over time.
Call Risk: Many muni bonds are “callable,” which means the issuer may pay them back before their maturity date if interest rates drop. While this can be advantageous if your interest rate risk is low, it also makes your bonds more volatile.
Municipal bonds are an attractive investment option for investors who wish to minimize taxes, maintain a diversified portfolio and can afford some capital loss in the short term. You can access various municipal bonds by purchasing individual bonds or investing in a bond fund. Municipal bonds offer various advantages over other investment options.
4. Liquidity
Liquidity is the degree to which assets can be quickly and easily converted to cash without affecting their value. This can be beneficial when you need cash quickly for an urgent purchase or investment.
Liquidity can help you assess your financial position and create a future plan. However, it’s essential to recognize that liquidity has different meanings in different circumstances.
Financial liquidity, for example, is a ratio that measures how easily a company can pay off its short-term debts with current assets. This figure is known as the “current ratio.”
Market liquidity refers to how easily a security can be bought or sold on an exchange. The more liquid a security is, the higher its market price will be.
5. Taxes
Investing in a tax-exempt municipal bond is an excellent way to maximize your after-tax income and protect more of your wealth from Uncle Sam. Although the yields on municipal bonds tend to be lower than those offered by taxable fixed income investments, the tax benefits can more than make up for that difference.
Investing in a tax-exempt bond offers the primary tax benefit of reduced federal income taxes. This can be especially advantageous for those in higher tax brackets.
Interest income on muni bonds is generally exempt from federal income tax and may also be exempt from state and local taxes. However, you should note that capital gains earned on these tax-exempt bonds must still be subject to both federal and state taxes.
