In these tough economic times, people are looking to put their money in safe investments. Municipal bonds offer investors safe and tax free income. In this article I will show you how to invest in municipal bonds
What Are Municipal Bonds
Municipal bonds are debt obligations issued by local governments. These types of bonds are issued to fund projects such as the building of roads,schools,highways,police station,hospitals and even sewer systems. Sometimes local towns and counties are unable to pay for their expensives with revenues, in order to create a balanced budget, they issue bonds. Bonds are essentially promises. In a bond the buyer gives money, called the face value, to the issuer. The issuer agrees to a certain interest rate, this is known as the bonds coupon. The bond is issued for a certain amount of time, sometimes is 6 months, sometimes it's 30 years. Once the maturity date is reached the bond issuer pays back the face value of the bond to the buyer.Basically a bond is a loan that investors make to the bond issuer. Municipal bonds, are bonds issued by state and local governments. There are two types of municipal bonds, general obligation bonds and revenue bonds.
General Obligation bonds are bonds that can only be issued by a organization that has the ability to levy and collect taxes. General Obligation bonds are issued and ensured by future taxes or revenue. In General Obligation bonds, the issuer can pay off the bonds from any source of revenue such as parking tickets.
Revenue Bonds are bonds that are backed by fees,penalties and other charges generated from a specific project. Unlike General Obligation bonds, revenue bonds are only ensured by revenues from a particular project such as a hospital or airport.
These two types of bonds are very similar but have minute differences that can be detrimental in some circumstances. I consider revenue bonds to be riskier since they are only backed by the income created from the projects they are issued for meaning if you invest in a revenue bond that is making a hospital and that hospital goes bankrupt, even if the government has a surplus of money, you will not get that because the bond you bought was only insured by the revenue the hospital was supposed to make.
How to Invest
Now that you know what Municipal bonds are, you may want to know how to invest in them. You can invest in Municipal bonds through many sources. You can go to the actual town hall to buy them, or go to your bank. The best way to find them is through a broker though. If you go through a broker, you will have access to a higher number of municipal bonds. I recommend going through your broker, this allows you to sell the bonds at any point in time, which gives you liquidity.
What Bonds to Buy
Now that you know where to buy bonds, you need to know what bonds to buy. There are many things to consider when deciding which Municipal bond to invest in but one of the most important is knowing the tax advantages. All municipal bonds are free from federal tax and some bonds are even free from state taxes. This is why Municipal bonds are popular among investors,because they offer great tax advantages. To get the biggest tax advantage from Municipal bonds, I would recommend investing in bonds issued by your state and local government. These bonds tend to have the best tax advantage for investors. Since they live in the state, they sometimes qualify for special tax benefits.
Another thing to consider is the bonds maturity date. Some bonds mature in over 20 years, and you might not be conformable waiting that long to get access to your money. If you are planning to buy more than one type of bond, try to ladder them in such a way that they mature at different times. This allows you to hae access to your money at stages when you need it. Here is an example. If I had 10,000 dollars, instead of putting all of it in one bond and waiting 20 years to get my principal back, I could buy one, 20 year bond one,10 year bond, and one, one year bond. That way every 10 years one of my bonds mature. This gives me diversity and stable income.
Make sure you also spread out the yield on the bonds you invest in. municipal bonds tend to have yields ranging from 1-7 percent. Try to spread out risk when investing and get bonds with different interest rates. The bonds interest rate or coupon is a good indicator of the risk level of the bond. High risk bonds have higher interest rates and low risk bonds have lower interest rates. Be sure too know what you are buying!
A final thing to consider when investing in bonds is the risk. Even though the bonds are issued by the government, they still have risks associated with them. Almost all bonds are rated by a rating agency and those ratings are pretty accurate of the risk level. The ratings go from AAA-D. AAA being the safest bond and D being a bond in default. Usually anything above BBB- is considered investment grade, and everything below it is considered junk status, or none investment grade. Almost all municipal bonds are above BBB-, so there is generally low risk associated with them. In conjunction with these ratings, be sure to do a your homework and research each and every bond you are planning on buying.
In conclusion, municipal bonds offer investors a great way to earn steady income. municipal bonds are generally considered safe but it is important to do thorough research before buying one. Make sure, you know the bonds rating and maturity date. Also make sure that you are getting a good interest rate. I hope this article has helped you learn about bond investing. If you enjoyed it, please check out some of my other articles!