December 30, 2009
If your investment portfolio consists of only equities, you may want to diversify. Stocks and other equity securities are an important part of your investment mix, but you may also want to consider some fixed income investments like municipal bonds. These will not only provide you with federal- and, in many cases, state-tax-free income, but they may also provide you with the satisfaction of supporting valuable projects or services in your state or community. Keep in mind, municipal bonds may be subject to the alternative minimum tax.
When you purchase a new-issue municipal bond, you actually make a loan to the issuer, like a city, township or school district. These entities use the funds raised from the sale of bonds to finance new streets, water and sewage systems, hospitals, parks, and many other improvement projects. In return for the use of your money, the issuer promises to pay you not only the principal amount back when the bond matures, but also a set interest rate, or coupon, during the term of the bond.
For many investors, the most favorable aspect of municipal bonds deals with the federal-tax-free income they offer. Investments must offer a substantially higher rate of return to be able to match the after-tax return available on a municipal bond. For example, if you are an investor in the 33 percent income tax bracket, you would have to find a taxable bond paying 7.46 percent to achieve the same after-tax return as what you would get from a municipal bond yielding 5 percent.
High-quality municipal bonds also provide a range of interest rates at various maturities, to help you plan for short-term or long-term income needs and typically have very low default rates. According to the Bond Market Association, less than 1% of municipal bond issues sold since 1940 have gone into either technical or actual default. It is also important to realize that you can find a lot of diversification just among municipal bonds themselves. This is because they are a major means of financing growth and expansion in a wide variety of communities and are issued in all parts of the United States. This provides you with a large selection of bonds from which to choose. In addition to geographic diversity, you will find an array of maturities, prices, coupon rates and other features that may be a good fit for your future needs. Every investment may not be right for everybody, but there may be a municipal bond out there that makes sense for you.
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).