What are the benefits and drawbacks of investing in municipal bonds?
Upside TaxExemption Most municipal bonds are exempt from federal taxation and state taxation in some instances. As a result buyers are able to earn a relatively competitive yield as compared to other types of fixed income treasuries and corporates. Additionally municipal issuers get to offer bonds at lower rates than their corporate counterparts since investors arent required to pay taxes on the income received from owning the bonds. Safety Municipals have a relatively low historical default rate due to the way they are structured. A significant amount of muni bonds are secured by property and sales taxes. Additionally taxsupported muni bonds are structured in a way that provides investors with a high priority of payment as compared to a corporate bond. Corporate bond investors generally have to endure operational risks while municipal bond investors are often shielded from the operational risks of a municipality. However the devil is in the details. Make sure you review the official statement and understand the flow of funds. Downside Liquidity Municipal bonds trade overthecorner OTC which essentially means there isnt a centralized trading system for the market. While municipal bonds are not completely illiquid the secondary market can be opaque. Investors must understand what they own and press their brokers for transparency. Retail investors tend to get the shortend of the stick when it comes to fair pricing due to the lack of a centralized marketplace such as the exchanges that equites trade on. Information Finding information on municipalities can be challenging. This is primarily due to the lack of regulations that require municipalities to disclose information in a similar manner as publicly traded corporations See the Tower Admendment of 1975. Historically this wasnt a big deal because bond insurance was widely available and default rates were low. However the bond insurance industry was decimated by the 2023 Credit Crunch and municipalities across the country are currently experiencing fiscal challenges. Investors should make sure to understand what they are buying and press brokers and municipalities to disclose information pursuant to their Continuing Disclosure Agreements can be found in the appendix of all official statements.