Investing your money has always carried some risks, but sometimes the risk may be low enough while the gains are attractive enough. This is the reasoning of most people who don’t like putting their money in a bank deposit or a time deposit account. Although these cash deposits are federally insured for up to $250,000, the paltry interest rates (a 1% interest rate is already a great deal) are simply not enough.
There are several ways of investing your money. You can start your own business, for example, or you may want to invest in real estate. The probability of failure in these investments is quite high, and the same can be said for investing in stocks, commodities, and foreign exchange. However, the possible returns can be huge.
Then there are also the municipal bonds, where the yield is somewhat low but the risks are much less. And you don’t have to pay federal taxes on the yield.
What are Municipal Bonds?
When you buy a municipal bond, what you’re actually doing is lending money to the institution issuing the bond. Often, this institution is a city or a town, or it can even be a school district. You then get paid the interest on a regular basis, and then on the specified future date you get back the money you used to buy the municipal bond.
Some municipal bonds are short-term, and they mature within a year. Others mature after more than a year’s time. The short term municipal bonds are usually issued because the city or town is anticipating some cash flow in the future, such as taxes. Municipalities then get the money they need to cover some sort of temporary deficit. If the local government needs the money now for some project, then it can issue municipal bonds to get the cash flow right away.
Long term municipal bonds are usually issued to cover construction projects that can take a while to complete. The money that the bonds generate is then used to cover budget deficits and for the creation or upkeep of roads and schools.
So Are Municipal Bonds for You?
That, of course, depends on “who” you are. Here are some factors which should be considered:
1. You belong to the very high income tax bracket. The tax-free benefits of municipal bonds remain the #1 most popular reason why people buy them. They’re not just exempt from federal taxes. They’re also exempt from state and local taxes if you bought municipal bonds issued in the state where you live.
So if you live in a city like New York where the taxes are high especially for the people in the top income brackets, then municipal bonds make more sense.
2. You don’t mind the tiny risk and the tiny yield. Bank accounts and time deposits are insured, but municipal bonds are not. Defaulting is always a possibility, although a very unlikely one. Even in the worst times the default rate was just 5.5%. For 2012, the default rate was less than 1%.
As for the yield, you can get anywhere from 3 to 5 per cent which is still a LOT better than putting your money in the bank, by the way.
3. You like to do your civic duty. If the thought of helping out your local government appeals to you, then municipal bonds may also be a good idea.
If all these statements apply to you then go right ahead and invest in municipal bonds.