Are you interested in investing in Municipal Bonds? They can provide great benefits if there benefits match up with your goals. Be careful; make sure you know how they work and how to maximize your investment and learn the disadvantages. Here are 5 secrets about municipal bonds.
Secret 1: Know the Municipal Bond Offering Calendar
Issuers of Municipal bonds are typically states and municipalities. Normally they close out their fiscal years on June 30th. Beginning with June and each quarter afterwards, more municipal bonds are entering the marketplace. These dates can give you much more opportunity to invest in new issues and to have ore chance to maximize your yield. The Wall Street Journal (and other publications) publishes these dates and offerings.
Secret 2: Rating Agencies Can Be Inaccurate
Rating agencies are paid to rate bond offerings and a supposed to be totally impartial. Recent discoveries by a government investigation has shown rating agencies have been influenced in the past in certain areas of investment vehicles. Rating agencies should be impartial and should use a standardized approach to quantitative models based upon the local economy, fiscal structure, and debt burden. Judging a municipal issuer’s capacity to pay their obligations, while qualitative factors, such as strength of management should also be part of the process, but often times not.
Ratings agencies should be dependable and probably more than not are, but be careful, it is possible they are making their judgment without 100% of the actual needed facts. Always get a second opinion and if possible, look at more than one rating for the same investment.
Often times the actual broker selling the investment will us its own independent rating service to offer a broader spectrum of information. Ask.
Secret 3: The Hidden Tax
Municipal bonds are tax free. But are they tax efficient?
When you buy an in-state municipal bond, you don’t have to pay Federal, state, or (where applicable) local income taxes on interest earned. Certain states such as Oregon, New York and New Jersey have large income tax rates above 8%. Even though the interest is not taxable of your federal income tax return, it is still counted as income when calculating income limits for your social security benefit. Yes, that is correct, interest earned on a nontaxable municipal bond counts against your social security limits, the same as if the earned interest was paid by a bank CD.
Secret 4: Will the Municipality Pay? Can the Bonds Be Re-Sold?
Many municipalities may be able to pay its debt obligations, the citizens of the municipality may not be willing to pay the taxes or accept the cuts in services required to meet its debt obligations. Look at past history; has the municipality lived up to its past obligations?
Recent bankruptcies by municipalities don’t necessarily mean they won’t pay their obligations but it could mean a discount to get your funds or having your bonds reissued as a much less interest rate.
If you need to sell the bond, is there a market? Many small municipalities offer an intriguing interest rate to buy their bonds, the flip side is that a market to re-sell the bonds prior to maturity may either be nonexistent or offering a huge discount. Make sure the market exists for your bond!
Secret 5: The Back Door Trap: Callability
Bonds offer a fixed interest rate for a fixed period of time (maturity). However, most bond offerings are written with an “escape hatch” for the rules to be changed in their favor. This is the callability rule. At a known time period (10 years as an example) the bond issuer may pay the bond in full and cancel the bond. This would be done if the bond issuer can reissue the bond at a lower rate. If interest rates are higher, the bond issuer simply keeps the bond in force and enjoys the financial advantage. In other words, you need to be very careful about buying or holding a bond that was issued several years ago. The issuer, can make changes to benefit itself, if there is no benefit to the issuer, the bond stays in force until the maturity date
Mutual bond do have a place in many portfolios, but use caution and make sure you fully understand the advantages and disadvantages.