Risks of investing in muni bonds

General obligation bonds , issued to raise immediate capital to cover expenses, are supported by the taxing power of the issuer. Interest rate risk. Most brokers are compensated through a markup over the cost of the bond to the firm.

Municipal bonds typically offer an attractive yield advantage over U. Treasuries for investors in higher tax brackets, but how much are you rksks in terms of risk to pick up the added yield? The short answer: not as much as you may think. Based on a study conducted by the fixed income rating agency Moody’s, yields on municipal bonds sufficiently compensate investors for the additional risks. Aaa is the highest possible rating; Aa is the second highest.

By buying a bond, the bondholder has committed to receiving a fixed rate of return for a set period. Should the market interest rate rise from the date of the bond’s purchase, the bond’s price will fall accordingly. The bond will then be trading at a discount to reflect the lower return that an investor will make on the bond. From a mathematical standpoint, interest-rate risk refers to the inverse relationship between the price of a bond and market interest rates. As you can see from the difference in the present value of these bond prices, there truly is an inverse relationship between the price of a bond and market interest rates, at least from a mathematical standpoint. From the standpoint of supply and demand, the concept of interest-rate risk is also straightforward to understand. Now, let’s determine what would happen if market interest rates increased by one percentage point.

Generally, the interest on municipal bonds is exempt from federal income tax. The interest may also be exempt from state and local taxes if you reside in the state where the bond is issued. Bond investors typically seek a steady stream of income payments and, compared to stock investors, may be more risk-averse and more focused on preserving, rather than increasing, wealth. Given the tax benefits, the interest rate for municipal bonds is usually lower than on taxable fixed-income securities such as corporate bonds.

In addition, municipal borrowers sometimes issue bonds on behalf of private entities such as non-profit colleges or hospitals. In cases where the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders.

Information available to you includes:. As with any investment, investing in municipal bonds entails risk. Investors in municipal bonds face a number of risks, specifically including:. Call risk. Call risk refers to the potential for an issuer to repay a bond before its maturity date, something that an issuer may do if interest rates decline — much as a homeowner might refinance a mortgage loan to benefit from lower interest rates.

Bond calls are less likely when interest rates are stable or moving higher. Credit risk. Credit ratings are available for many bonds. Credit ratings seek to estimate the relative credit risk of a bond as compared with other bonds, although a high rating does not reflect a prediction that the bond has no chance of defaulting.

Interest rate risk. If bonds are held to maturity, the investor will receive the face value amount back, plus interest that may be set at a fixed or floating rate.

If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond. Inflation risk. Inflation is a general upward movement in prices.

Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of. It also can lead to higher interest rates and, in turn, lower market value for existing bonds. Liquidity risk. Many investors buy municipal bonds to hold them rather than to trade them, so the market for a particular bond may not be especially liquid and quoted prices for the same bond may differ. Tax implications. Consider risks of investing in muni bonds a tax professional to discuss the bond’s tax implications, including the possibility that your bond may be subject to the federal alternative minimum tax or eligible for state income tax benefits.

Broker compensation. Most brokers are compensated through a markup over the cost of the bond to the firm. This markup is usually not disclosed on your confirmation statement.

If a commission is charged, it will be reported on your confirmation statement. You should ask your broker about markups and commissions. The background of the broker or adviser selling the bond. These organizations may charge a fee. Municipal Bonds. What are municipal bonds?

Where can investors find information about municipal bonds? Investors should be aware that recent price information may not be available for bonds that do not trade frequently.

Investors in municipal bonds face a number of risks, specifically including: Call risk. In addition to the risks, what other factors should you consider when investing in municipal bonds? Email Address.

Aaa, Aaa, and A are considered investment grade, while the remaining tiers are below-investment-grade, or lnvesting yield. These organizations may charge a fee. Inflation risk. General obligation bonds are issued to raise funds right away to cover costs, while revenue bonds are issued to finance infrastructure projects. That number quadrupled afterhighlighted by seven defaults in Popular Courses. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of. By Thomas Kenny. Continue Reading. The short answer: not as much as you may think. This approach seeks to generate income from yields and capital gains from selling at a premium.