In a dynamic financial environment filled with fanciful terms like IPO and arbitrage, it’s easy for the more plain-vanilla variety of investments to be overlooked or even forgotten. Such is the case with municipal bonds and their wallflower nature, providing an invaluable financial backbone to the framework of society. Yet they are rarely the focus of financial headlines or most conversations.
Don’t let their inconspicuous nature deceive you, however. Municipal bonds can play a critical role in the average investor’s financial strategy in various ways, including tax efficiency, diversification, and risk management. In other words, while certainly not as flashy as stocks or their corporate bond brethren, municipal bonds can be beneficial under the right circumstances.
Municipal Bond Basics
Although various instruments can be classified as municipal bonds (muni bonds for short), typically speaking, they are debt obligations issued by some form of municipality where the funds are used for the public benefit. Frequently, muni bonds are issued by states, cities, counties, or some form of a government agency to improve highways, schools, hospitals, and many varieties of public works projects.
In general, our tax code entices investors to invest in municipal bonds by offering tax incentives matched by few other investments. Although it’s in your best interest to consult a tax professional to see if a particular municipal bond or muni bond fund meets your tax efficiency expectations, the interest yielded on munis are generally tax-free on your federal taxes as well as your state taxes as long as the municipal bonds are issued within your home filing state.
Dampening Portfolio Volatility
Since municipal bonds are very much part of the fixed income spectrum of investments, they are typically helpful to dampen volatility experienced in other portions of your allocation, particularly equities. Lower-quality bonds tend to exhibit more volatility than higher-quality bonds, so make sure the bonds or bond funds you use are suitable for your needs.
Of course, you can invest directly into municipal bonds and use them individually or in a laddered approach. However, given the popularity of mutual funds and ETFs, you can also invest in munis through a far more liquid and convenient investment, lowering your interest rate risk by taking a more diversified approach.
Have questions about whether municipal bonds should play a part in your portfolio or need help with your financial plan? We’re here to help! Simply click here or call (763) 445-2772 to schedule a complimentary consultation today!