Which municipal bonds are safe

Credit ratings, however, should not be the sole basis for any investment decision. In general, as with any fixed-income investment, the higher the yield, the higher the risk. All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable.

By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.

Over the past 10 years, the average default rate for investment grade municipal bonds was 0. Nevertheless, municipal bonds defaults are not uncommon. There were 10 defaults in , seven of which were associated with Puerto Rican debt crisis. The year average default rate for investment grade municipal bonds was 0. Municipal bonds generate tax-free income and therefore pay lower interest rates than taxable bonds.

Investors who anticipate a significant drop in their marginal income-tax rate may be better served by the higher yield available from taxable bonds. Many bonds allow the issuer to repay all or a portion of the bond prior to the maturity date.

The investor's capital is returned with a premium added in exchange for the early debt retirement. While you get your entire initial investment plus some back if the bond is called, your income stream ends earlier than expected.

The interest rate of most municipal bonds is paid at a fixed rate. This rate doesn't change over the life of the bond. However, the underlying price of a particular bond will fluctuate in the secondary market due to market conditions.

Changes in interest rates and interest rate expectations are generally the primary factors involved in municipal bond secondary market prices.

When interest rates fall, newly issued bonds will pay a lower yield than existing issues, which makes the older bonds more attractive. Investors who want the higher yield may be willing to pay more to get it. Likewise, if interest rates rise, newly issued bonds will pay a higher yield than existing issues. Investors who buy the older issues are likely to do so only if they get them at a discount.

If you buy a bond and hold it until maturity, market risk is not a factor because your principal investment will be returned in full at maturity. Should you choose to sell prior to the maturity date, your gain or loss will be dictated by market conditions, and the appropriate tax consequences for capital gains or losses will apply. The most basic strategy for investing in municipal bonds is to purchase a bond with an attractive interest rate, or yield, and hold the bond until it matures.

The next level of sophistication involves the creation of a municipal bond ladder. A ladder consists of a series of bonds, each with a different interest rate and maturity date.

As each rung on the ladder matures, the principal is reinvested into a new bond. Both of these strategies are categorized as passive strategies because the bonds are bought and held until maturity. Investors seeking to generate both income and capital appreciation from their bond portfolio may choose an active portfolio management approach, whereby bonds are bought and sold instead of held to maturity.

This approach seeks to generate income from yields and capital gains from selling at a premium. Stability is a relative term in the municipal bond market. Municipal bonds tend to be safer than many other types of investments, but they are less safe than U.

Treasury bonds. You can also trade in multiple kinds of municipal bonds, such as assessment bonds, revenue bonds, or general obligation bonds. Revenue bonds are issued by municipalities to finance revenue-generating projects like a toll road or concert hall. The cash generated by the project itself will pay back investors in those bonds.

Revenue bonds have higher default rates than general obligation bonds since the funds are used for a specific project, which may or may not be completed on time and within budget and may not generate the projected revenues. So it's important to research the issuer's credit rating before risking your capital.

New issues are bonds that a municipality sets up for a new project. The secondary market is where you can buy bonds that are already issued from other investors or sell not-yet-matured bonds you already hold. Bond funds are investments in a fund that owns bonds.

You own a stake in the bonds via your ownership of that fund. In all of these cases, you'll buy and sell through a broker, similar to how you invest in stocks. It's important to understand the fees you'll pay, as well as the potential "markup" -- a selling price above face value -- of the bond. Brokers who buy and sell municipal bonds are required to register with the Municipal Securities Rulemaking Board MSRB , which governs the muni bond market.

They're required to disclose certain pricing information so that you, as an investor, can understand what you're paying. A mutual fund or exchange-traded fund ETF that invests in bonds might be appropriate as well. Your investment in a muni bond fund gives you a small stake in every municipal bond the fund owns. The benefit is instant diversification , which can help you avoid losses from being too exposed to a single bond.

The downside is potentially high recurring fund management fees. On the whole, municipal bonds have a low default rate. Between and , there were only 99 muni bond defaults issued. Of these, only nine general obligation bonds defaulted, and not a single municipal bond with the highest credit rating defaulted.

Municipal bonds have been 50 to times less likely to default than corporate bonds. However, municipal bonds still are not risk-free. In recent years, some governments have defaulted on their municipal bonds, including Detroit in and Puerto Rico in So if interest rates go up, bond prices come down, and vice versa.

If you purchase a bond and later interest rates rise, you are locked into receiving a return less than what you would receive by buying a new bond at the higher interest rate. Thus, the price or market value of your bond falls as your bond is worth less. Call risk: Some muni bonds are callable, which means the issuer can decide to repay the bond earlier than the maturity date.

When interest rates fall, an issuer with the ability to call their bond may choose to do so because the issuer can save money by refinancing or reissuing another bond at a lower interest rate. If you think they have a place in your portfolio, there are a few ways to get started. You can buy individual muni bonds or muni funds in your online brokerage account, and many robo-advisors offer munis as part of their portfolio mix.

Individual bonds: Many investors purchasing muni bonds have a buy-and-hold strategy, intending to hang on to them until maturity. These investors can research and select bonds that work best for their portfolio in terms of risk and return, maturity date and tax benefits. Municipal bond ladders: When you purchase an individual bond and hold it, you don't get your principal back until the bond matures.

Some muni bonds mature in one to three years, while others mature in 20 or 30 years. Investors needing regular income might consider buying multiple bonds and building a ladder, with bonds maturing annually or in whatever time increment that fits their situation and cash flow needs. Muni funds: For those who might not feel comfortable picking municipal bonds on their own, investing in munis through mutual funds or exchange-traded funds , also known as ETFs, can make sense.

One benefit is accessing a well-diversified portfolio of bonds from municipalities with different credit ratings, a range of projects and bond types GO or revenue , and varied risk and return.

This lessens any potential default risk as you spread your dollars across many bonds. Another benefit is shifting the onus to someone else well-versed in municipal bonds, namely the fund manager, to keep tabs on the municipalities and related risks for you. Some investment management companies offer state-specific funds so investors can benefit from both federal tax exemption as well as state and local tax exemption. How muni bonds work. Types of muni bonds.