Municipal Bonds are a good investment for holding on to your capital and creating an income stream that is usually tax free. When you invest in a municipal bond, you are loaning money to a government entity. You receive interest payments over a period of time and your original capital is returned to you when the bond matures.

Should I Invest in Taxable or Tax Exempt Municipal Bonds?

The interest paid on tax exempt municipal bonds is usually exempt from federal taxes, and is sometimes exempt from state and local taxes as well. Tax exempt bonds are popular. There are, however, tax circumstances where it may be more beneficial for you to invest in taxable bonds. The choice of whether to invest in taxable or tax exempt bonds depends in part on your tax bracket, your income, and the change in your tax status over time. Study the tax codes that pertain to bond investments or consult a tax advisor.

 What are Types of Municipal Bonds That I Can Invest In?

• General Obligation Bonds

• Revenue Bonds

How Can I Gauge the Risk in Municipal Bond Investing?

Municipal bonds are generally considered a low-risk investment. There is a high likelihood that the bond issuer will repay their debt. However, the element of risk is still present, if small. The following risk factors can be used to determine if a municipal bond investment is right for you:

• Credit Risk

This refers to the possibility that the bond issuer may be unable to pay interest on the bond, or the principal upon bond maturation. Moody’s Investors Service and Standard & Poor’s are rating agencies that rate the creditworthiness of a bond issuer. An AAA rating indicates an issuer with little or no credit risk. Ratings like “Ca,” “C,” “DD,” or “DDD” indicate a bond issuer in default or lacking creditworthiness. Bonds rated “BBB” or better are considered acceptable for investors who want to preserve their original investment.

• Interest Rate Risk

While the interest rate of most municipal bonds is a fixed rate, interest rates in the general financial markets affect bonds. As general interest rates rise, your municipal bond yields will fall relative to the returns on more recently issued bonds.

• Risks Associated with Changes in Your Tax Bracket

If you expect your tax situation to put you in a lower tax bracket, it may be more advantageous for you to invest in taxable bonds, which pay higher interest than tax exempt municipal bonds.

• Call Risks

Your bond may be called in early. Though your capital is returned (with a premium for the early retirement of the issuer’s debt) you’ve lost the stream of income from the interest payments that would have continued over the original maturity period for the bond.

• Market Risk

Market risk is a factor to consider if you wish to sell your bond prior to maturity. Interest rates in the marketplace will affect what you are able to get for your bond. If interest rates are falling, your bond will be more desirable than more recently issued bonds, which are paying a power yield. If interest rates rise, your bond will yield less than more recently issued bonds, and you may have to sell your bond at a discount.

What Else Can I Do to Determine Which Municipal Bonds to Invest In?

Research the municipality that is issuing the bond. Examine the risk factors and make sure the issuer is creditworthy. Find out what you can about the project or initiative that the bond will fund.