People who are looking for convenient ways to diversify their investment portfolios may be interested in the advantages offered by municipal bonds. Municipal bonds are issued by local governments. City, county, and state governments sell municipal bonds, and they use the revenue for projects like new schools or better roads. When investors purchase municipal bonds, they are tax-free which means that the purchaser does not have to pay any federal income tax on the yield of the bond. In most cases, the purchaser will probably not have to pay state income tax either.
There are two main kinds of municipal bonds. One type is called general obligation while the other type is referred to as a Revenue Munis. General obligation bonds are secured by the fact that the issuer of the bond (the city, state, or county government) has the ability to tax people. That implies that the issuer will indeed be able to repay the value of the bond. Revenue Munis, on the other hand, are not issued directly by the government. Instead, they are issued by government sanctioned organizations like water companies or electric companies. These organizations secure their bonds by the fact that they will be able to collect revenue from their customers to repay the bond.
The main advantage of a municipal bond investment is the fact that they are tax-free. However, many investors have difficulty determining whether they prefer a convenient tax-free municipal bond or a taxable corporate bond. To determine which investment is right for you, you may use the following formula: tax exempt yield divided by tax bracket.
Thus, if an investor was considering a tax-free municipal bond that promised a yield of 5% and they were in a tax bracket that charged them 15%, they would take the .05 (5%) divided by .85 (85%). The result in that example is .0588. That means that if an investor wanted to buy a taxable corporate bond, they would need to purchase one that had a yield rate of at least 5.88%. If they bought a corporate bond with a lower yield rate, they would not earn as much as they would with their 5% yield municipal bond.
In most cases, municipal bonds are considered to be a very safe investment. However, these tax-free investments are not always foolproof. When deciding whether or not you want to invest in municipal bonds, you should look at their rate of return in comparison to your tax rate, and you should look at the organization or community that issues that bond. Ideally, the issuing city should have a population of at least 10,000 people, they should have a diverse economy, and they should have a positive history of repaying bonds.