Are Municipal Bonds Still a Safe Investment?

Municipal bonds – debt obligations issued by states, cities, towns, or public commissions to help pay for projects such as schools, roads, hospitals and other public works – have long been a popular investment, particularly among high net worth investors, offering relative safety and a predictable stream of tax-free income (free from federal and often free from state and alternative minimum taxes). But with many cash-strapped states and municipalities facing considerable financial strain these days, are muni bonds still safe?

While many investors have panicked and fled the muni bond market in recent weeks, most experts contend that while their level of risk has increased, muni bonds can still be an appealing investment for investors who exercise sufficient due diligence when selecting them.

Before investing, remember that there are two main types of municipal bonds – general obligation or revenue. With general obligation bonds, the principal and interest are backed by the full faith and credit of the issuing municipality and supported by the issuer’s taxing power. This means that state and local governments can raise taxes in order to pay them off, which may add and extra measure of protection for the bondholder.

With revenue bonds, the principal and interest are secured by revenues received from a specific project. In some cases, these bonds can offer a slightly higher yield than general obligation bonds. Many bond experts recommend investing in revenue bonds that are tied to essential municipal services, such as water and utilities, while being more careful in selecting bond issues whose income stream is less certain.

Another thing to remember is that the default rate on muni bonds is historically very low. In fact, according to Moody’s Investor Service and Standard & Poor’s rating agencies, the historic default rate of investment-grade muni bonds is less than 0.1 percent.

In short, muni bonds can still be a viable and attractive investment; however, in light of the current economic environment, it’s very important that you do your homework before selecting the right muni bonds for your portfolio. It’s also important to note that when interest rates rise, bond prices will fall. A qualified financial advisor can help you sort through the thousands of available bond issues and select the investment opportunities that are best suited for your risk tolerance and time horizon. 

Chris Lacy is a Senior Vice President/Investments and Branch Manager with Stifel, Nicolaus & Company, Incorporated, Member SIPC and New York Stock Exchange. He can be contacted in the Palm Desert office at 41-990 Cook Street or by phone at (760) 834-6900 or toll-free at (877) 879-3158.