Most financial advisers consider a municipal bond a safe investment. There are several types available from which an investor can choose, and they can be purchased through the federal government, foreign governments, or through corporations. One of the most beneficial aspects of such investments is that the individual is assured of getting his or her initial investment back.
Types
Municipal bonds are debt obligations issued by governmental entities such as counties, cities, and states. When an individual purchases such a bond, he or she is essentially lending money to a local or state government entity. The issuer promises to pay the bond’s owner a specific amount of interest—paid semiannually in most cases—as well as return the principal at a specific time in the future. The money is frequently used by the government entity for projects such as new hospitals, highways and schools, as well as numerous other projects that will benefit the general public.
Corporate bonds are issued by public securities markets and are technically an avenue through which a company can sell off its debt. They typically have higher interest rates, which means they are also associated with higher risks.
Tax Considerations
In the United States, a municipal bond typically features tax free interest growth, although in certain states some exceptions may apply. For instance, the nature of the project the bond will be funding has a direct influence on the taxability of its income. As a rule, if the project will in whole or in part benefit only private parties, state and federal tax will apply to the income. These are commonly referred to as private activity bonds and are an exception to the tax exempt rule.
Comparing Bonds
The coupon rate of a bond is a term that refers to the interest an individual receives once it has matured. This number is communicated in the form of a percentage and is based on the bond’s par value. For instance, if an investor purchases a bond with a $2,000 par value and a yearly coupon rate of 5%, he or she would receive $100 each year until it matures and the principal is paid to the investor.
Due to the fact that municipal bonds are typically tax-exempt, if one compares the coupon rates of corporate or other taxable bonds to municipal types, he or she may easily become confused. For instance, if taxes must be paid on the bond’s interest, the net income it yields will be lowered. It is for this reason that a tax-exempt municipal bond has a higher yield than a corporate bond, even if the coupon rate is the same. The coupon rate is not always the determining factor regarding a bond’s rate of return.
Such investments can be an excellent way to expand one’s portfolio; however, it is essential that he or she evaluate the details of the investment before deciding to make a purchase. These details include the interest rate of the bond, the stability of the issuer, the repayment provisions and length of the term.
