It’s not easy being a bond investor these days. Bonds are generally thought of as conservative investments. But as we’ve seen this year, even conservative investments like bonds can lose money. Having said that, it’s not all doom and gloom for bondholders. Instead, I think there is potential opportunity in the municipal bond market.
Here are three reasons I like municipal bonds:
Reason #1 to like munis: Tax-free interest
Municipal bonds are issued by states and local municipalities to finance the construction of roads, schools and other infrastructure. The interest they earn is usually exempt from federal income taxes, and if issued in the town or state you reside may be exempt from state and local taxes as well. Meanwhile, the interest on private activity municipal bonds is taxable unless otherwise indicated.
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Tax-free income can be especially useful for retirees or highly compensated executives who have other income, such as pensions, annuities and deferred compensation plans, because it can help prevent “bracket creep” — when a taxpayer is bumped up into the next tax bracket. No one likes a creep, especially a bracket creep. That’s why I turn to municipal bonds for their tax-free interest.
Keep in mind that while muni interest is generally tax free, capital gains from selling a bond, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax.
Reason #2 to like munis: Be greedy when others are fearful
So far 2022 has not been kind to municipal bonds. As of April 12, 2022, the S&P Municipal Bond Index is down 6.78% for the year. Investors may have been spooked by events in Ukraine, inflation and the prospect for higher interest rates.
This is reason No. 2 why I like muni bonds. Research from investment firm Lord Abbett looking back over the past 12 years has shown there have been six distinct outflow cycles for muni bonds, and in the subsequent 12-month period the performance was overwhelmingly positive. Past performance is no guarantee of future results, but strong performance has typically followed large outflows in municipal bond funds.
Reason #3 to like munis: Low default risks
According to Moody’s Investor Service’s annual U.S. Municipal Bond Defaults and Recoveries snapshot, from 1970-2020 the default rate – when a bond fails to make interest or principal payments – remains “rare” overall for municipal bonds, at 0.08% over the course of the study. Even during the Covid pandemic up through 2020, according to investment firm VanEck, there were only two municipal bond defaults, and neither were virus related.
Muni bonds are by no means risk-free, but the low risk of default is comforting for my conservative clients.
Final thoughts
Municipal bonds have their advantages and disadvantages and are not suitable for all investors. However, given the reasons listed above, I think municipal bonds can help as part of a diversified portfolio.
There are many ways to purchase municipal bonds, including buying a bond fund, multiple different bond funds or individual bonds. There are short-, intermediate- and long-term as well as different types of municipal bonds, such as general obligation and revenue bonds. There are pros and cons to each approach. If you are unsure, I advise in speaking with a professional.
For more information on how to invest in municipal bonds or for a complimentary investment review of your portfolio, please email me at maloi@sfr1.com.
Investors cannot directly purchase an index. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Investment advisory and financial planning services offered through Summit Financial, LLC, a SEC Registered Investment Adviser. Income is generally free from federal taxes and state taxes for residents of the issuing state. While interest is tax free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax. This newsletter is provided for informational purposes only and is not intended as specific advice or an offer to buy or sell any securities. Summit Financial, LLC and its affiliates do not provide tax or legal advice.
Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.
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