In an era of economic uncertainty many investors look for safe investment alternatives. Given the fluctuating risks and rewards of owning stocks, investors are looking for alternatives that can provide steady income with less risk. One such alternative is municipal bonds. They can offer an attractive rate of return and frequently have favorable tax incentives. The worth of municipal bonds is relatively more stable than stock prices and the interest received during the life of the bond is usually tax-free. There are several alternatives when investors want to purchase municipal bonds including primary markets, secondary markets, and municipal bond funds.
The primary municipal bond market is for the sale of Initial Public Offerings (IPO’s) by individual companies or securities dealers. In general, unless you have a previous connection to the bond underwriter or a prior investment relationship with the bond issuer, you buy a bond IPO just like you would other stocks and bonds – from an investment broker. It is typically difficult to buy into an IPO as an individual investor because companies have great latitude when deciding how to sell IPO’s. Frequently individual investor’s are not included in the initial sale unless they have a very large dollar investment amount, are an active bond trader, or have an investment account at the firm that is underwriting the bond issue. Investment companies such as Merrill Lynch and Morgan Stanley typically underwrite part of a large bond IPO and may offer their pool of individual investors the chance to invest in municipal bond initial offerings. For other investors it is more likely they will acquire their bonds on the secondary market.
The secondary bond market is much like the stock market where individual investors are selling bonds they no longer wish to own or bond brokers are breaking up large blocks of bonds bought during an IPO and offering them to individual investors. You can buy municipal bonds in the secondary market through most investment brokers and many banks. Because many bonds are long-term investments, usually between seven and thirty years, investors frequently choose to sell bonds before the maturity date. These bonds are purchased by bonds dealers or bond desks at large investment firms and offered to other investors.
The most important things to consider when choosing individual municipal bonds issues to purchase are bond ratings and taxation. Bonds are rated according to how likely it is the bond issuer will be able to make all future payments. Typically municipal bonds rated A and above are safe based on the fact that it is extremely rare for defaults to occur. However, even though municipal bonds are rarely defaulted, economic problems for the issuing municipality can cause a bond’s rating to fall very low making them very difficult to sell. If bonds with downgraded ratings can be sold, they are frequently sold at heavy discount. It is wisest to invest money in bonds that you that you do not plan to access for several years.
If the idea of figuring out bond premium or discount values, the future value of interest payments, and the tax aspects of investing in individual bond issues seems like more than you want to consider, it may be simpler to invest in a municipal bond fund. You can purchase shares in municipal bond funds from many investment companies, brokers, or banks. For many bond funds you can buy in for only a few thousands dollars. Bond funds can be found with a wide range of risk levels and rates of return. They may be widely diversified or focused on a number of bond issues in only one state. Single state bond funds are of particular advantage for residents of that state because bond interest payments are generally tax exempt in the state of issuance.
Although, past performance indicates default is unlikely for municipal bond issues, default may become more likely during times of unprecedented economic upheaval such as during the sub-prime mortgage crisis. Municipalities in some of the hardest hit states are facing budget shortfalls that may lead to lower bond ratings and a decrease in the value of bonds. In extreme cases, some municipalities may be forced to file bankruptcy, which could make bonds worthless. For this reason a large investment in an individual bond issue, bond funds that hold a large amount of only a few bond issues, or bond funds that concentrate on one state can be more risky. For example individual bond issues in Michigan or bond funds that focus on Michigan may suffer lower returns and an increased likelihood of default when the main industry of the state, automobile manufacturing, suffers an extreme decline. It is necessary therefore to research any bond issue or bond fund you are considering for investment to minimize these risks.
Municipal bonds can be an attractive investment alternative in times of economic crisis or as a source to diversify an investment portfolio. Whether through purchase in the primary or secondary markets or by investing in shares of a bond fund, the relatively stable prices, steady income, and tax advantages make municipal bonds an excellent investment choice. Once you have chosen between investing in individual bond issues or purchasing shares of a bond fund, it only takes one call to an investment broker or banker to begin your municipal bond ownership.