Municipal bonds are worth considering if you wish to preserve your capital and at the same time generate an income that is tax-free. Municipal bonds are generally issued by the government entities. When you purchase a municipal bond you loan your money to the issuer in exchange for interest payments over a specific period. When the bond reaches the maturity date you get your original investment back.
They are available in taxable as well as non taxable formats. The tax exempt bonds get more attention since they generate income which is exempt from federal. The interest rate for municipal bonds is fixed and does not change over the life of the bond. They generate tax-free income and pay lower rates of interest than the corporate bonds. As a result big investors prefer municipal bonds in order to reduce their federal taxes.
The lower tax bracket investors are not benefited by these bonds. It is advisable to purchase a municipal bond that offers high interest rate and keep the bond till it matures. The next step is to create a municipal ladder that consists of a set of bonds with each bond having different interest rates and maturity dates. As every bond on the ladder matures the principal is again invested in the new bond.
Municipal bonds come in two varieties namely General Obligation bonds and Revenue bonds. General obligation bonds are supported by the taxing power of the bond issuer. They are backed with full faith of the issuer whereas Revenue bonds are not backed the taxing power of the government. The interest rates and principal amount are supported by the issuers taxing power. General Obligation bonds are issued by the state with an intention of raising the capital.
While purchasing municipal bonds is considered to be a safe investment strategy it is not free from risks. If the issuer does not meet the financial obligations it may fail to repay the principal upon its maturity. The rating agencies carefully analyze the issuer’s ability to meet the issue ratings. The bonds which are rated as BBB and baa are considered to be an appropriate investment. Some of the municipal bonds are supported by the insurance policies which guarantee the repayment in case of the event’s default.
In case of rise of interest rates in the market the bond owned will pay a lower yield in relation with the newly issued bonds. The price of the bond changes with the market conditions. When the bonds market price raises the interest rates fall and with rise in the interest rates the market value of the bond declines. The investors who own the fixed rate municipal bond and sell it before its maturity then they could lose money since there is lower market value for the bond.