“Municipal bonds” is a word that everyone has heard of. Have you ever wondered what municipal bonds are? Why these bonds are considered as one of the safest investments? How do these bonds work? Most importantly, what are the perks and risks of buying these Bonds, and why has the market for these bonds risen to $4 trillion?

To answer all these questions and guide you about these bonds, we have covered everything about investing in municipal bonds in 2024.

An Overview of Municipal Bonds

Municipal bonds, or Munis, are debt obligations issued by local government. When you buy a municipal bond in exchange for interest for a certain period, when that period arrives, the bond reaches its maturity time, and you will receive the investment that you’ve invested in these bonds.

Types of Municipal Bonds

There are two types of municipal bonds:

General Bonds

A general obligation bond, or (GO bond), is issued by government entities, while property taxes back some GO bonds. GO bonds are the most secure form of municipal bonds. Therefore, they have the lowest interest rate.

Revenue Bonds

It guarantees interest payment and the principal amount by any income stream. For example, the bond issuer invests the capital in water uti; when the customers pay for this service, the bond issuer will pay you interest from that profit. Remember, the revenue bond issuer can invest in any public service like tolls, airports, hospitals, bridges, or any other sewage treatment service.

How Does Municipal Bond Work?

As explained earlier, municipal bonds are debt security issued by the state, municipality, or any other government entity to finance capital expenditures. In simple words, the money you invest in these bonds, these entities or the bond issuer invest in public service projects, and when the public pays them fees, these entities pay interest to the bondholders.

Benefits of Investing in Municipal Bonds

Following are the benefits that you can gain by investing in municipal bonds:

Tax-Free Income

One of the most significant advantages of investing in munis is tax-free income. The interest of municipal bonds is usually exempt from federal income tax. Sometimes, it comes from state and local sources. This tax-free profit makes it a good investment for investors.

Stability

Municipal bonds are considered safer investments than risky investments like stocks. Municipalities, like counties, don’t usually default on their debt compared to private companies. As a result, municipal bonds are often considered a stable and safe investment.

Predictable Income

Municipal bonds usually pay interest regularly (e.g., once in 6 months). This predictable income benefits investors. This income can appeal more to income-focused investors, such as retired people.

Diversification

They also give you a chance to diversify your portfolio. If you invest in different assets, it can reduce your overall risk portfolio. For example, municipal bonds may cover that loss if your stocks perform poorly.

Various Yields

Municipal bonds come with different maturities. It ranges from short-term to long-term. Investors can choose bonds that meet their investment, goals, and patience level. The municipal bond yield can also differ. This yield allows investors to select bonds that match their desired income level.

Risks of Investing in Munis

These are a few disadvantages of investing in municipal bonds:

Lower Yield

Municipal bonds have lower yields than other bonds, like corporate bonds with the same maturities. Because low risk leads to low reward, investors seeking higher profits may find higher returns in other fixed-income securities.

Interest Rate Risk

Municipal bonds are sensitive to changes in interest rates. If interest rates rise, the value of existing bonds may decrease. However, investors may face the risk of selling their bonds at a loss if they need to liquidate their bonds before maturity.

Credit Risk

Generally, municipal bonds are considered safer than corporate bonds. But there is still a risk of default. Not all municipalities are financially stable. In contrast, some may face financial challenges that could change their ability to meet debt obligations. Some credit rating agencies analyze the creditworthiness of municipalities. But there's always uncertainty.

Market Liquidity

Municipal bonds may not be as liquid as other investments, like stocks or U.S. Treasuries. This illiquidity makes it difficult to sell the bonds quickly. Illiquidity could impact an investor's ability to exit a position at a desirable price.

Economic Risk

Economic instability and political clashes can impact the financial health of municipalities. Economic downturns or changes in local leadership can affect the ability of municipalities to generate revenue and meet their debt obligations.

Essential Points To Know About Investing In Municipal Bonds

Three strategies are used for investing in munis:

The Basic Strategy

The basic strategy for investing in municipal bonds is buying bonds with an attractive yield/interest. After the bond's maturity date arrives, invest the primary capital + interest in another bond.

Municipal Bond Ladder

This strategy is one of the best moves for buying these types of bonds. The municipal bond ladder strategy is to buy a series of bonds of different interests and maturity dates. After each bond matures, you invest your yield and capital into another bond. This strategy is also called passive strategy.

Active Portfolio Approach

The active portfolio approach is the third and last investment strategy for buying municipal bonds. In this strategy, you buy a bond, then you sell the munis before its maturity at a premium. Now, you have a capital appreciation as well as the yield of the bond.

Similarly, you invest in another bond, gain some yield, and sell at a premium before maturity. This strategy is one of the best investing strategies for municipal bonds.

Are Municipal Bonds tax-free?

Usually, municipal bonds are tax-free. However, in some cases, the profit of munis can be taxed at the state or income tax level.

The minimum amount you need to invest in municipal bonds is at least $5,000. In addition, Some ETFs and mutual funds offer municipal bonds. Municipal bond rates range from $5,000 to $100,000.

Bottom Line

That’s all you need to know about investing in municipal bonds 2024. To conclude, municipal bonds have perks and risks attached to them. However, we also discussed some wise strategies to invest in these bonds. But make sure you take advice from finance professionals or certified brokers before investing in munis.