It’s Hard To Go Wrong With Municipal Bonds

What if I told you that you could invest with 99.92% confidence that you would make money?

That’s been the success rate of municipal (muni) bonds over the past 51 years. In other words, fewer than 1 muni bond out of every 10,000 has defaulted since the Richard Nixon administration.

Municipal bonds are loans that investors make to governments or quasi-governmental organizations. Some bonds are what are known as general obligation bonds, in which case the money is used by the city or county for general purposes. They are considered incredibly safe because of the taxing power of the issuer. Essentially, if the city or county couldn’t pay the bond, theoretically, it could levy taxes to do so.

Other muni bonds fund specific projects, such as a hospital, school or toll road. Often, the interest on those individual projects is paid by the revenue generated by the project. But they are typically less risky than they sound, thanks to the backing of the city or county where they are located.

Because muni bonds are so safe, they normally pay lower rates of interest. However, the interest is usually free from federal and state taxes, so your after-tax return is often similar to that of a taxable bond.

For example, if you own a corporate bond with a 3% yield and are in the 32% tax bracket, after paying federal taxes, you will wind up with 2.04%. If you live where there are state income taxes, your rate will be lower still.

If instead, you buy a muni bond with a 2.25% yield, you won’t pay any tax on that 2.25% and will make more money after taxes than you would with a corporate bond.

Now, keep in mind, that’s on the interest only. The price of the bonds will affect your total return.

Muni bonds, like other bonds, trade at a discount or premium to par value ($1,000), so if you pay more or less than par, it will change your total return.

With today’s incredibly low-interest rates, it’s tough to find decent muni bonds that pay a generous yield to maturity (the total return of the bond based on interest and price appreciation/depreciation at maturity).

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