INSIGHTS

On April 12, 2016

AAM Viewpoints - 5 Reasons to Consider Investing in Municipal Bonds

Even in this low interest rate environment in which we find the 10-year Treasury bond yielding a 1.71, there is still a strong need for income, both tax fre­e and taxable, in the municipal bond market. With the demographic shift that is occurring, investors want and need fixed income investments. The following 5 reasons are why an investor may want to consider the municipal bond market to fill their income needs.

1. Federal and State Income Taxes
   

   Most people would rather not pay taxes of any kind. The income received from a tax-exempt municipal bond is federally tax free. As far as state income taxes, the income received from most tax exempt municipal bonds are not subject to state income taxes where the investor resides. Some states do not have a state income tax so the investors in that state can buy municipal bonds issued from any state and not pay state tax. This situation helps when diversifying credit risk in a municipal bond portfolio as the investor can diversify regionally without a penalty for paying state income taxes on out-of-state bonds. When diversifying credit risk, it may be worth paying state income taxes on out-of-state municipal bonds in order to achieve that diversification. Whether you pay a state income tax or not, when trying to diversify, investors may want to look first at out-of-state municipal bonds issued in states that do not have state income taxes. Since there is no tax advantage for an in-state person to invest in municipal bonds from their own state, generally the yield received from municipal bonds issued in states without state income taxes is higher than states that have a state income tax.

   
   

   There are also Municipal Bonds that are taxable. The income from a taxable municipal bond is subject to Federal Income taxes bonds and may or may not be subject to state income taxes depending on the state in which you reside. Please consult your investment and tax professional for specifics on individual bonds.

   
   


2. Safety and Quality
   

   Other than U.S. Treasury bonds, municipal bonds are generally considered a safe asset class in which to invest with respect to credit risk. Although there have been defaults in municipal bonds, historically, the overall asset class is considered relatively safe. Investors’ primary concern relating to safety is the issuer’s ability to meet its financial obligations. Issuers disclose their record of meeting interest and principal payments in offering documents which can be found on the Municipal Securities Rulemaking Boards Electronic Municipal Market Access. Please consult an investment professional when deciding which particular municipal bond in which to invest.
   
   
   
   

   
   


3. Diversification
   

   At the end of 2011, there was over $3.7 trillion in municipal bonds outstanding. Just as important, this $3.7 trillion in debt was represented by over 1 million different bonds issued by thousands of different issuers. There are a lot of different choices.

   
   

   Besides the thousands of different issuers and over a million different bonds from which to choose, the different types of issuers with their different revenue sources securing the credit of the municipal bonds provides numerous ways for the investor to diversify. An investor can diversify by region, state, locale, maturity, rating (credit), and by source of revenue backing the bonds. There are general obligations bonds, essential purpose revenue bonds (for example water and sewer revenue bonds), hospital revenue bonds, tax increment bonds, power bonds, highway bonds, etc. It is strongly suggested to consult a financial professional for advice on how to properly structure a diversified portfolio.

   
   


4. Saving for Goals
   

   Municipal Bonds have a maturity date when the principal is returned to the investor. This is not only helpful for investment planning, it is also a good way to save for a particular goal. For example, a tax-exempt zero-coupon bond may be a good way to save for a personal financial goal such as paying off a home mortgage, college tuition, etc. A tax-exempt zero-coupon municipal bond automatically reinvests the coupon payments back into the bond and since the bonds are tax exempt, the investor does not pay federal taxes annually on the principal growth of the bond. Barring a default of the municipal issuer, investing in Municipal bonds can be an efficient way to meet future cash needs.

   
   

   Market prices of zero-coupon bonds tend to be more volatile than bonds that pay interest regularly. Investors should consider the credit worthiness of the issuer and pay careful attention to any call previsions.

   
   


5. Comfort
   
   There is a certain comfort level many investors find owning municipal bonds. You can invest locally where the investor knows and is familiar with the credits. You can invest in local school bonds, local sales tax bonds or in the state’s general obligations where you live. If you have a favorite area you vacation or visit, the municipal bonds from those locales may be of consideration. If these bonds are out of state it is a good way to diversify the geographic risk.
   
   
   
   In today’s global economy where investments are subject to worldwide events, there is a certain comfort in knowing that economic or geopolitical risks may not have as an immediate impact on your municipal bonds the same way as the impact on, for example, global corporate issuers. Yes, eventually even the most local of municipal issuers are eventually affected by global events, however, the impact may not be as immediate. Of course, there are global events that can have an impact on all, or particular, municipal issuers.

There are so many choices and opportunities that investing in municipal bonds present that it can indeed get confusing. I urge the investor to engage a financial consultant to determine which municipal bond investment best suites their financial needs and goals. Investors should also consult their accounting, legal or tax advisors before investing.

CRN: 2016-0401-5246R

An investment in Municipal Bonds is subject to numerous risks, including higher interest rates, economic recession, deterioration of the municipal bond market, possible downgrades, changes to the tax status of the bonds and defaults of interest and/or principal. A bond’s call price could be less than the price paid for the bond. Bonds typically fall in value when interest rates rise and rise in value when interest rates fall. Bond insurance covers interest and principal payments when due and does not insure or guarantee the value of any bond in any way.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at https://www.aamlive.com/legal/commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.