on 17 May, 2014 at 14:00

Municipal bonds represent an attractive investment for people looking for assets that give tax-advantaged income. Thus, interest payments for municipal bonds are not subject to federal taxes. If such bonds are issued by the state in which the investors reside, they are free of state taxes. Moreover, if they are actually issued by the city in which the investors reside, they are free of city taxes. Generally, municipal bonds make sense for investors in the 25% federal tax bracket and higher. Prior to investing in such bonds, it is great to first explore its pros and cons of doing so to ensure that you are making the most informed investment decision. But what is a municipal bond?

Advantages of Municipal Bonds

Probably, one of the biggest advantages related to investing in municipal bonds is the fact that they’re likely tax free. In a brief view, a person does not have to worry about paying taxes on his/her interest income, at least not federal. A person may have to pay local and state taxes depending on where he/she lives, unless he/she purchases a triple tax-free bond which exempts him/her from all three.

One of the strengths of municipal bonds is that they are relatively low risk compared to other bonds. Since municipal bonds are government debt securities backed by the credit or activities of your town, there is likely money offered to take good care of your interest and the completely invested amount once they reach the maturity date. Moreover, they are also reliable and genuine as their default rate from year 1970 to 2000 was 0.04 percent.

• Highly Level of Liquidity. They are traded and highly liquid on a secondary market. This implies that if you’re strapped for cash or in need of a certain amount of money for emergency or investment opportunity, the capital can be accessed quickly.

• Lower Volatility Than Stocks. Historically, municipal bonds have been one of the safest places to park your savings and also provide tax exempt returns.

Disadvantages of Municipal Bonds

• Opportunity Cost. You should visit any websites offering online calculators that would calculate your taxable equal yield. It is for you to ensure that your bonds make more sense for you than any other bonds.

• Bond Yields Might Not Beat Inflation. Since this kind of bond is quite a conservative investment, it offers tax advantages and their yields tend to be relatively low. Therefore, they’re less likely to beat inflation compared to stocks. This implies that the money you’ve parked in a bond fund can be worth less in buying power many years from now.

• Interest Rate Risk. Current bonds lose value when interest rates go up. This is due to the fact that bonds that carry lower interest should be sold at a discount rate to the same current bond yields. However, this can be a less concern if you hold the bonds for maturity, but can be a hindrance if you need to cash out bonds or bond funds.