Is it a good time for mu­nic­i­pal bonds

The Covington News - - Local news -

As the year winds down, you may find your­self re­view­ing your in­vest­ment strat­egy to de­ter­mine if you made the right moves in 2008 to help you achieve your fi­nan­cial goals. And one topic you may well fo­cus on is tax-ad­van­taged in­vest­ing. Did you do all you could in this area? If not, you might want to con­sider a pop­u­lar, but of­ten mis­un­der­stood, in­vest­ment: mu­nic­i­pal bonds. And right now, th­ese types of bonds may be more ap­peal­ing than they’ve been in many years.

Es­sen­tially, a mu­nic­i­pal bond is a debt se­cu­rity is­sued by a state, mu­nic­i­pal­ity or county to fi­nance its cap­i­tal ex­pen­di­tures, such as bridges, high­ways or schools. The in­ter­est you re­ceive from mu­nic­i­pal bonds is ex­empt from fed­eral taxes and from most state and lo­cal taxes, es­pe­cially if you live in the state in which the bond is is­sued.

None­the­less, if you’re like many peo­ple, you might dis­miss mu­nic­i­pal bonds as con­ser­va­tive in­vest­ments that usu­ally of­fer lower yields than tax­able Trea­sury or cor­po­rate bonds. (The yield is the re­turn you will re­ceive on your bond if you hold it un­til ma­tu­rity.) But what you may not re­al­ize is that if you are in one of the up­per tax brack­ets, the tax sav­ings you re­ceive from your mu­nic­i­pal bonds may be enough to pro­vide you with a higher yield than you’d get from a com­pa­ra­ble Trea­sury or cor­po­rate bond.

Fur­ther­more, in re­cent months, we’ve seen some­thing that rarely oc­curs: mu­nic­i­pal bonds yield­ing as much as, or more than, Trea­sury bonds — even without tak­ing the tax ben­e­fits into ac­count. Why has this hap­pened? For a va­ri­ety of cir­cum­stances, the mar­ket has be­come some- what “glut­ted” with mu­nic­i­pal bonds; this over­sup­ply has led to lower prices. And bond prices are in­versely re­lated to yields, so the drop in mu­nic­i­pal bond prices has led to the higher yields.

Thus far, we’ve seen that to­day’s mu­nic­i­pal bonds fea­ture tax ad­van­tages, low prices and rel­a­tively high yields. Yet like all in­vest­ments, mu­nic­i­pal bonds do carry some types of risk, in­clud­ing the fol­low­ing:

• Credit risk — Dur­ing dif­fi­cult eco­nomic times, mu­nic­i­pal­i­ties may be strapped for cash and have trou­ble meet­ing their fi­nan­cial obli­ga­tions — such as sched­uled in­ter­est pay­ments on their bonds. It’s a good idea to in­vest in a mu­nic­i­pal bond whose is­suer is con­sid­ered highly cred­it­wor­thy, as de­ter­mined by the rat­ings it re­ceives from an in­de­pen­dent rat­ing agency, such as Moody’s or Stan­dard & Poor’s.

• Call risk — When mar­ket in­ter­est rates are fall­ing, a mu­nic­i­pal­ity may want to buy back — or “call” — its bonds so that it can reis­sue new ones at the lower rates. Ob­vi­ously, if your bond is called, your in­come stream will be dis­rupted. That’s why you may want to look for mu­nic­i­pal bonds that of­fer call pro­tec­tion — a pe­riod of time dur­ing which the is­suer can­not call the bond.

One fi­nal note of cau­tion: Some mu­nic­i­pal bonds are sub­ject to the al­ter­na­tive min­i­mum tax (AMT), so, be­fore in­vest­ing in a muni, con­sult with your tax ad­vi­sor.

Once you un­der­stand th­ese risks and take the steps we’ve sug­gested to ad­dress them, you may find that mu­nic­i­pal bonds can play a valu­able role in your port­fo­lio, so give them some con­sid­er­a­tion.

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