The Advantages of Municipal Bonds
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The largest advantage of municipal bonds is, undoubtedly, the fact that the interest payments you make on it are free from federal – and quite possibly state and local – taxes. Of course that is not the only advantage municipal bonds can give you. Municipal bonds are used to construct schools, highways, and other projects that benefit the community in which you live and the contractor’s who build these public places may very well hold a few of these municipal bonds as well. This allows them to reap the tax benefits while still being able to carry on their work.
As an investor, municipal bonds can also offer you the same tax breaks. Those interest payments that are made to you and considered income are tax free. The tax break you receive on municipal bonds provides you with what is called a ‘taxable equivalent yield’. This is how much interest you would have to earn on a taxable bond to get the same tax break that you do on municipal bonds. The higher your own tax bracket, the higher your taxable equivalent yield on your municipal bonds will be.
For clarification sake, not all municipal bonds are free from taxes. Airport and housing municipal bonds in particular are subject to an alternative minimum tax (AMT). The yields on these municipal bonds tend to be higher than regular municipal bonds, but in order for them to be advantageous to you, you need to know whether or not you will be assessed an AMT on it. If you are, skip investing in this type of municipal bond. If you will not be assessed, then you will want to seek out more information about them.
Municipal bonds are issued as general obligation bonds and revenue bonds. The general bonds are used to finance activities that are supported by the state and local governments. Revenue bonds are used for larger, more specific projects, like hospitals and airports. The municipal bonds issued for more contractors are revenue bonds and if you are wanting to support the building of these types of public works, then you may wish to look into municipal bonds for revenue.
You can diversify your portfolio by investing in municipal bonds. They do not move with the fluctuating stock markets and you are guaranteed to receive the money you invested plus all of the interest that is paid over the municipal bonds lifetime. Because they do not fluctuate, municipal bonds are also the most secure investment you can make. Try to invest ones that have the highest bond rating an agency can give it. That way the municipal bond is insured and the rates will not fluctuate. Invest in municipal bonds that are varied in their terms as well. This way you’ll be assured a flow of income as the market fluctuates with the changes around it.
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