What are tax-free muni bonds? Learn the unique benefits and risks of this debt-security investment vehicle.
If you’re aiming for something near the polar opposite of “hot investment topic” territory, you may run across municipal bonds. But although tax-free muni bonds—aka munis—may not be the rock stars of the investment world, they do possess several unique attributes that might make them worth a look. Their range of focus is highly regionalized, and their financial impact often does not exceed the boundaries of a city, county, or state. And perhaps because of their relatively narrow scope, munis rarely get the spotlight.
But tax-free muni bonds comprise a massive $3.8 trillion market (as of 2017, according to the MSRB), and they offer unique characteristics and potential benefits that might make them worth considering as an investment vehicle. And generations of retirees and investors seeking a relatively safe, diversified, and tax-advantaged way to generate steady income appear to have flocked to municipal bonds.
New to municipal bonds? Let’s take a closer look at what these fixed-income securities might have to offer. Specifically:
States, cities, counties, and school districts are among the municipalities that issue muni bonds to raise capital for public works—capital expenditures that typically involve building, maintenance, or upgrades of roads, bridges, buildings, and other infrastructure.
Muni bonds are considered “debt securities”—tradable financial instruments with predefined principal amounts, interest, maturity, and other terms. Munis are also considered fixed-income securities, meaning that, as an investor, you can expect to receive periodic interest payments (typically every six months) of a non-variable amount until the bond matures. And unless the bond issuer defaults—a rare occurrence with munis—you can expect to be repaid the principal amount you had initially invested.
Perhaps what investors find most attractive about municipal bonds, and what differentiates them from other fixed-income securities, are the tax advantages.
Here’s a short list of the potential advantages that distinguish munis from other bonds:
As with every investment, municipal bonds also have risks and drawbacks. Here are a few to consider:
Municipal bonds may be a conservative means to diversify your portfolio and generate a stable stream of income, but, like most everything, munis carry a certain degree of risk. There’s also some opportunity cost—meaning that returns could be lower than what you might have received if you invested in something with a higher risk/reward factor. So despite the potential benefits, muni bonds aren’t for every investor.
Before investing in municipal bonds, be sure to do your homework. Weigh the pros and cons, not only of municipal bonds (or bonds in general), but also for the real communities where munis are at work.
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