Municipal bonds. They may sound confusing or scary, but they could be the key to your financial success.
But what are they and how do you buy them? Known as “munis” or “muni” bonds, they are short-term assets you can buy from a state, municipality or county looking for investors to fund capital projects, like building a highway.
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When you purchase the bond, that money goes toward the government’s project. In return, the government pays you interest over a set amount of time. At the end of the bond’s lifespan, known as its maturity date, the original amount you paid for the bond is also given back to you.
Make sense? There are some serious benefits munis can give you, boosting your investment portfolio with traditionally little risk. When it comes to understanding municipal bonds, here are the top four points you need to know before deciding if buying munis are the right choice for you.
1. Known for low, but steady, yields. If you’re still scarred from the recession, muni bonds may be an easy way for you to dip your toes back into investing. Because they’re shorter-term, don’t expect huge interest payouts. Yet the regular payments back into your bank account give you something you can count on in what you may see as an otherwise volatile investing market.
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2. Gains are tax-exempt. That steady income stream from interest payments may be small, but they won’t shrink once tax day comes around. Being federally tax-exempt is one of the reasons munis are especially popular within higher tax brackets. But remember that being tax-exempt is all a matter of the law, and as tax law reform became a hot topic this year, excluding muni bonds fell under Congress’s microscope. If a current bill passes as is, this benefit may not be there for long.
3. Use mutual bond funds. There’s a reason the saying goes don’t put all your eggs in one basket. Spreading investments across many industries, or in this case, across many states or counties, will help ensure your portfolio won’t take a big hit it one bond sees a drop in value. By investing in a municipal bond fund, you will invest in a pool of munis from across the nation instead of choosing them individually. This will diversify your muni bond portfolio and will help smooth out any bumps you encounter.
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4. A low-risk alternative. Most muni bonds are backed by an insurance policy, guaranteeing that at maturity, the bondholder will get their money back. That cuts risk a lot. But not completely. Before investing in a local government, check its credit rating. If national organizations like Standard and Poor’s or Moody’s Investor Service call the government risky, steer clear.
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