| Tax free municipal bonds |
| Written by Henry Johnson | |
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Tax-free municipal bonds are an increasingly popular investment tool as the current economic crisis has driven treasury bills lower and fear about other investments has driven investors to take a second-look at these ultrasafe places to stash their cash. Municipal bonds, more commonly known as "munis" are debts taken out by city, county and state governments to pay for community projects such as a new highway, civic facility, school or hospital. The main attraction of these IOU's are that the interest paid to the owner of a municipal bond is exempt from federal taxes, and often state taxes as well. The interest rate on these bonds is usually lower than that of other "safe" investment like Treasury bills, but because big institutional investors are currently flocking to T-bills seeking shelter from the current economic climate, munis are now enjoy a higher rate of return. According to USA Today, the average municipal bond yields 3.16%, compared with just 2.84% for a five-year Treasury note. Once the impact of federal and state taxes are considered, the muni bond becomes even more attractive. For example, if you're in the 25 percent tax bracket, you'd need that 2.84% five-year T-note to yield 4.21% to earn the equivalent of the muni's 3.16% once federal taxes are taken out. In general, munis are most attractive to investors in high tax brackets who have a lot of money to invest and desire a steady flow of tax-free income from a low-risk investment. Municipal bonds fall into two categories. General obligation bonds are issued to pay for projects such as schools and sewer systems, and are considered to be very safe investments. The bonds are backed by the issuer's ability to generate revenue from local taxes. Revenue bonds are issued by state or local government supported entities such as a utility company. These bonds are backed by revenue generated by the state-supported business that issued the bond. Not much information is available concerning the safety of individual municipal bonds. Investors are forced to rely on credit ratings assigned by credit agencies to gauge the risk involved with their investment. Investors considering munis should find out who is responsible for paying the interest payments on the bonds and the economic health of the bond issuer. Investors shouldn't feel too skitish about munis, however. According to USA Today, only less than one percent of all municipal bonds default, compared to about 3 percent for all other bonds. To purchase a muni, contact a Municipal Securities Rule-Making Board-registered dealer or banker There are nearly 3,000 bankers and dealers are registered municipal bond dealers nationwide. A common strategy many investors employ for investing in municipal bonds is to buy a bond with a good interest rate and hold the bond until it matures. More sophisticated investors often create a municipal bond ladder. A ladder is made up of a series of bonds, each with it's very own maturity date and interest rate. As each bond matures, the principal from the matured bonds are plowed into a new bond. Because the bonds are bought and held until they mature, investors define both of these strategies as passive strategies. For investors with a lot of capital who want to avail themselves of a safe, tax-free source of income, municipal bonds may be the safe harbor they're looking for in the current stormy economic climate. |
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