Why do I like Municipal Bonds?
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There are many reasons to like Municipal Bonds, here are my top three:
1. Tax-free interest: Municipal bonds are issued by states and local municipalities to finance the construction of roads, schools, and other infrastructure. The interest is exempt from Federal income taxes and if issued in the town or state you reside may be exempt from state and local incomes as well (the interest on private activity municipal bonds is taxable unless otherwise indicated).
Tax-free income can especially help retirees or highly compensated executives who have other income such as pensions, annuities, and deferred compensation plans. Tax-free interest can help prevent further bracket creep - when a taxpayer is bumped up into the next tax bracket.
2. Be greedy when others are fearful. So far 2022 has not been kind to municipal bonds. As of March 21, 2022 the S&P Municipal Bond Index is down 4.52% for the year. Investors may have been spooked by events in Ukraine, inflation, and the prospect for higher interest rates. This is reason number two to love muni bonds. Research from investment firm Lord Abbett has shown looking back over the past 12 years there have been six distinct outflow cycles for muni bonds, and in the subsequent 12-month period the performance was overwhelmingly positive. Past performance is no guarantee of future results, but the evidence is clear: strong performance has typically followed large outflows in municipal bond funds.
3. Low default risks. Generally speaking, the odds for municipal bond default are low. According to the Balance, an investment publication, "From 1970 to 2011, only 0.8% of municipal bonds that were rated investment grade defaulted (i.e., failed to make interest or principal payments) within 10 years after issuance." Muni bonds are by no means risk-free, but the low risk of default is comforting for clients. What to watch out for: Municipal bonds are sensitive to changes in the economy. According to the St. Louis Federal Reserve, in the financial crisis of 2008, rates fell, and the bond market gained over 5%, but municipal bonds lost ground. It reflects a year when a recession started. People who invested their money were steering clear of risks at that time.
Municipal bonds are not as safe as Treasury bonds or cash, but they do provide a reasonable solution for investors seeking tax-free income. In addition, given the dramatic declines in prices, in my opinion, municipal bonds present an opportunity for long-term investors.