David Lerner Associates News: Are Municipal Bonds a Smart Investment in 2014?
Municipal bonds have long been popular investments among some individuals due to their tax-free status and income-generating properties. Earnings from muni bonds are generally exempt from federal income tax, as well as state and local income tax for residents in the state in which they live. And tax-free municipal bonds typically pay interest ever six months.
What Is a Municipal Bond?
A municipal bond is a type of fixed-income investment issued by state and local governments and their agencies to raise money for public projects like schools, hospitals, roads and bridges. The issuer agrees to make interest payments to bondholders at a fixed rate and repay the principal amount in full on a future date.
According to David Lerner Associates Executive Vice President William Mason, the tax-free status of municipal bonds has historically made them an attractive investment. For example, the taxable equivalent yield of a Metropolitan Transportation Authority of New York municipal bond maturing in 2038 with a yield of 4.30% is 6.62% for those in a 35% federal income tax bracket.
“Tax-free municipal bond yields are especially attractive now when compared to long-term treasury bonds, which on 2/26/14 were yielding 3.34%,” says Mason. “Tax-free yields are also well above current inflation rates, typically ranging between 1 and 2 percent.”
Municipal Bond Risks
There are two primary risks involved in purchasing municipal bonds. Credit risk is the risk that a bond might be downgraded or the issuer might default and fail to repay the principal, while interest-rate risk is the risk that rising rates could erode bond prices. Bond prices have an inverse relationship to interest rates: When one rises, the other falls and vice-versa.
It is this second risk that has some pundits predicting a potentially rocky year for municipal bonds in 2014, given that some experts expect interest rates to rise this year. But Mason largely discounts structuring a portfolio based on market predictions. In determining whether or not municipal bonds are the right investment, he encourages investors to try to consider whether they are a wise choice for their portfolio at this particular point in time. “Diversification is also important,” he adds. “Investors should structure their portfolios to weather all kinds of potential market conditions.” This usually means creating an asset allocation with the right mix of bonds, stocks, and cash equivalents based on their particular investment objectives.
Potential Positives for Munis
One factor that could boost municipal bond prospects this year is the new Obamacare Medicare surtax. This 3.8% tax will be assessed on passive income (i.e., investment) profits earned by high-income couples and individuals. But municipal bond income is exempt from the Medicare surtax, which could make muni bonds more attractive to high earners.
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA & SIPC