How to Invest in Muni Bonds
Cities across the world take in money from the taxes paid by their residents and businesses in their limits. Often, however, they will need to use more money than they have on hand, and at these times they turn to one of the largest financial markets on the globe. About $1.7 trillion in outstanding municipal paper was held by investors in 2005. Municipal bonds are attractive to investors because they provide low-risk fixed income and are often tax-free. Municipal bonds do not trade on an exchange, but can be purchased through a broker registered with the Municipal Securities Rulemaking Board.
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Instructions
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Buy a bond fund. Mutual funds that are invested in bonds, including municipal bonds, are fairly popular because they can be easier to buy and sell and to understand than buying bonds directly. As always, consider the load fees, commissions, and other costs associated with a bond fund before buying, and consider previous performance and management style to get a grasp of the potential risks.
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Buy through a broker. A first-time buyer of an actual muni bond will probably require the assistance of a professional broker. Factors to consider when buying a bond are the price and yield, how the repayment of the bond will be financed, frequency of interest payments, and total transaction costs. Also, some bonds may be callable or putable, meaning the borrower or lender can call in the debt prior to maturity of the bond, potentially affecting the overall return.
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Sell bonds. Municipal bonds can be held to maturity with relatively low risk, but because interest rates and credit ratings can fluctuate, it can be desirable to sell bond holdings before maturity. For example, if interest rates fall, investors may be willing to purchase an older muni bond at a premium to its original sale price. Conversely, if a city's credit rating falls and it faces default, it may be desirable to sell the bond, even at a loss.
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Tips & Warnings
Revenue bonds are paid from money earned through the specific activity they were designed to fund. For example, a bond that financed the creation of a toll road or bridge might be paid back through the tolls collected once it's built. This, however, carries the risk that revenues will not meet expectations. General obligation bonds, on the other hand, are linked to the city's taxing power and are therefore a lower credit risk.
Profits from a bond fund may be taxed as capital gains and not carry the tax free status of the underlying debt instruments.
While the municipal bond market is generally very liquid, bonds in smaller may be difficult to sell quickly at times.
Though rare, cities can and do declare bankruptcy and default on their loans. Consider the financial situation of the municipality before investing in its debt.
