Municipal bonds are issued by both the local and state governments, also known as municipalities. These bonds are issued to raise funds for public projects like construction, hospitals, schools, water treatment facilities, and maintenance of bridges. The municipality is a bond issuer that sells the bond to the bondholders. The investors investing in the bonds are known as bondholders.
How does a municipal bond work?
When a state is spending huge funds on public projects like construction, the state government issues municipal bonds to the public to raise funds. Investors can buy any amount of those municipal bonds and the state will pay coupon rate at regular intervals as specified in the bond. These coupon rates are the interest payments you earn when you purchase municipal bonds. Municipal bonds have many forms as there are debts from different bodies like states, countries, and government-connected municipalities. Municipal bonds are usually guaranteed by the government. The length of the bond term is known as bond duration. The government bodies pay the bond back at the end of the bond’s duration.
What are the risks involved in the municipal bonds?
Some municipal bonds are backed with full faith and credit of the government. Whereas, other municipal bonds are revenue-backed, which means that they are tied to the success of the project that is being funded. Most of these funds have default rates that have been below 0.03% over the last decade.
What are the safest ways to invest in municipal bonds?
Most people prefer to invest in municipal bonds through a bond fund to yield high interest from the municipal bonds. When you prefer to invest in high-yield municipal bonds, it is always safer to invest through a bond fund rather than purchasing the municipal bonds on your own. The three main types of bond funds are mutual funds, closed-end funds (CEFs), and ETFs. Most people with typical funds have more than 100 municipal bonds in their portfolio. Some of the reasons that make municipal bonds worth the buy are-
- Firstly, municipal bonds, unlike stocks, are not traded electronically all the time. Most of the municipal bonds are rarely traded and it is very common that a municipal bond has not been bought or sold for six months or even more.
- The time period of a municipal bond is a lot shorter than that of a stock. There are various companies that have their shares in the market for decades and they aren’t going away anytime soon. Whereas, a typical municipal bond is redeemed after six years or so. The term redeem means that the principal amount that was invested by the investor, is returned to him and the bond gets dissolved.
However, municipal bond funds tend to rely more on IPOs than most stock investors do. Municipal bonds aren’t released to everyone in open public. Most of the best bonds are kept by bond brokers and underwriters with themselves or are offered to their high-end clients. This means that a regular investor is often left with the scraps of municipal bonds.
What is the relationship between the interest rate and municipal bonds?
The relationship between changing the interest rate and a bond’s value is known as convexity. This simply means that higher the convexity of a bond, higher is the chances of the rates of the bond to decrease when the interest rates rise. The interest rates of municipal bonds are not great as they are one of the safest forms of investments.
Which are the three high-yield municipal bonds?
While investing in high-yield municipal bonds, it is always recommended to understand the funds before investing. Don’t listen to what you have heard, conduct your own research rather than just investing in a municipal bond because your friend told you about the great guaranteed returns. It is always advisable to invest only in the funds you understand. Below are some high-yield municipal bonds based on year to date (YTD) returns.
- MFS Municipal High Income Fund
This high-yield municipal bond seeks total return with an emphasis on the exemption of high-income from federal income tax and also, considers capital appreciation as well. At least 80% of its net assets are invested by the fund in securities and other investments. The interest earned on these are exempted from federal income tax. This is one of those high-yield municipal funds that has returned 3.99 percent over the past five years, and 5.72 percent over the past decade. The fees of this fund are below average compared to the other funds in this category.
- T. Rowe Price Tax-Free High Yield Fund
This high-yield municipal bond seeks a high level of income. This fund invests in primarily long-term low- to upper-medium-grade municipal securities. Usually, 80% of this fund’s income is exempted from the federal taxes. However, the remaining 20% could be derived from securities that are subjected to minimum tax. The fund has returned 3.87 percent over the past five years and 5.63 percent over the past decade. However, the risk is above average compared to other funds of the same category.
- Invesco High Yield Municipal Fund
Under normal market conditions, the fund invests at least 80% of its net assets in municipal securities at the time of investment. However, the fund may not invest more than 25% of its net assets in industrial development revenue bonds issued for companies in the same industry. It is one of those high-risk municipal bonds where the risk is high as compared to other funds in the same category. The fund has returned 5.47 percent over the past year and 5.80 percent over the past decade.