Investing in Bonds - Corporate, Treasury Or Municipal?

When you buy a bond, you are actually loaning your money to the organization that issued the bond. That is why bonds are often called "debt instruments." The principal (the "face value" of the bond) is repaid on the maturity date. In the meantime, you are paid a set amount of interest, usually every six months. This interest is called the "coupon" or "coupon rate." It's called that because bonds used to come with little coupons attached that you would cut off and send in twice a year to receive the interest payment. Nowadays, the coupon rate is nothing more than the annual interest rate.

When deciding which types of bonds to invest in, it's important to know all you can about each. Among the types of bonds you can choose from are:

Treasury Bonds

Treasury bonds, also known as "T-bonds" for short, are issued by the United States government and are considered to be the safest of the three bonds. The only risk is if they are sold prior to maturity (but this holds true for all bonds). Super-safety comes at a cost, though, and in the case of treasury bonds that means lower returns than other bonds.

Interest is paid on treasury bonds twice a year, and can be purchased in maturities ranging up to 30 years. All T-bonds bonds are issued in face values of $1,000 with different purchase minimums with each type of security. It is impossible to redeem a treasury bond before maturity, and interest payments stop as soon as the bonds mature.

Corporate

Corporate bonds are issued by companies in order to raise capital. While they can be very safe investments when issued by strong, established companies, the reverse is true for companies that are not rock solid. Unlike treasury bonds, corporate bonds have what is known as a "call provision", which allows the bond holder to get their principle investment back before maturity.

Most corporate bonds have fixed interest rates, and some, called "zero coupons" are sold at a significant discount in exchange for the bondholder agreeing to wait until maturity to receive interest payments.

Because determining which companies are strong and which aren't can be very tricky, there are companies who evaluate the fiscal integrity of various corporations to determine their bond-worthiness. Moody's Investors Services and Standard and Poor are two examples of such rating companies.

Municipal

Municipal bonds are issued by state, county, or city governments for the purpose of financing government sponsored functions (I.E., building a highway or a school), or for other "non governmental" purposes, such as raising money for low income housing or student loans.

Municipal bonds, like T-bonds, pay interest twice a year. These investments can be very safe, but do carry risks as well. Moody's and Standard & Poor rate municipal bonds based on their credit quality, so when investing in them, it's a very good idea to use these ratings as a guideline.

Municipal bonds are subject to significant market risk if sold before maturity.

Maintaining a Diversified Portfolio

Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual circumstances and objectives. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital or to receive dependable interest income. Whatever the purpose-saving for your children's college education or a new home, increasing retirement income or any of a number of other financial goals-investing in bonds can help you achieve your objectives.

Assessing Risk

All investments offer a balance between risk and potential return. The risk is the chance that you will lose some or all the money you invest. The return is the money you stand to make on the investment.

The balance between risk and return varies by the type of investment, the entity that issues it, the state of the economy and the cycle of the securities markets. As a general rule, to earn the higher returns, you have to take greater risk. Conversely, the least risky investments also have the lowest returns.

The bond market is no exception to this rule. Bonds in general are considered less risky than stocks for several reasons:

o Bonds carry the promise of their issuer to return the face value of the security to the holder at maturity; stocks have no such promise from their issuer.

o Most bonds pay investors a fixed rate of interest income that is also backed by a promise from the issuer. Stocks sometimes pay dividends, but their issuer has no obligation to make these payments to shareholders.

o Historically the bond market has been less vulnerable to price swings or volatility than the stock market.

The average returns from bond investments have also been historically lower, if more stable, than average stock market returns.

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What is a Municipal Bond

A Municipal Bond (or muni) is a bond issued by a city or local government in the United States. Some of the bodies that can issue Municipal Bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports and any other governmental entity below the state level.

Guarantee for Municipal Bonds is provided by the local government, a subdivision of the local government, or a group of local governments. All Municipal Bonds are pre-assessed for risk and are given an appropriate rating.

In most cases, the income generated by a Municipal Bond holder by the interest on the bonds is exempt from both the Federal Income Tax and the State Income Tax (for the state in which the bonds were issued). There can be exceptions to this and certain bonds could be declared taxable.

Whether the income received by bondholders through the interest on the bonds is taxable depends largely on the type of projects that are funded by that bond. For instance, if the bonds were issued to gather money for a construction that is meant for the welfare of the public, those bonds are not likely to be taxed. On the other hand, if the bonds are used for a project that would only benefit a handful of private parties, then the federal or state taxes might be applicable.

The laws for determining which bonds are to be taxed and which are not are very complicated. The taxable status of every bond is fixed before it reaches the market. If you are a regular buyer of Municipal Bonds then you should know that not all of them are tax-exempt.

The risk (or security) associated with a Municipal Bond is determined on the basis of the ability of the issuing body to make all payments on time and in full, as pledged in the agreement between the issuer and the bond holder. Different bonds have different types of securities based on the commitments that are formally documented in the bonds.

Some of these are:

* General Obligation Bonds - These assure that the bond value will be repaid on full faith and credit of the issuer. These bonds are supposed to be the most secure Municipal Bonds and carry the lowest interest rates.

* Revenue Bonds -These assure that the bond value will be repaid from a stream of future income once the project is complete. Toll payments are frequently used to pay for such projects. These Municipal Bonds are slightly risky because they rely on the success and profitability of the project. They do carry a slightly higher interest rate.

* Assessment Bonds - These assure that the bond value will be repaid based on the property tax assessments of the properties located within the issuer's boundaries.

There are rating agencies used for the purpose of determining the probability of repayment as is assured by the bond issuer before the bonds are issued.

Standard & Poor's, Moody's, and Fitch are the three top rating agencies for Municipal Bonds in the United States. Any bond issuer can sign up with these agencies to get a bond rating.

Bond buyers must pay close attention to the rating before purchasing any bonds.

Check out http://www.bond-trading.org/ for articles on eurobond and municipal bonds.

Lebenthal On Munis: Straight Talk About Tax-Free Municipal Bonds for the Troubled Investor Deciding "Yes...or No!"

IF YOU KNEW WHAT I KNOW...
Would you buy a municipal bond for the subways in New York City that’s rated AA-, or only A?
Would you care what a bond is for as long, as it’s a general obligation backed by the issuer’s full faith, credit, and taxing power?
Would you pay 109 for a bond, a premium of $90 for every $1,000 face value, knowing you’re going to get back only $1,000 at the end??Would it be crazy to buy a 30-year bond at age 80?
Would you read “these bonds are not a debt of the state” as a fair warning, Buyer Beware??Tax free municipal bonds.  Would you buy them at all?
STRAIGHT TALK FROM THE MAN WHO PUT MUNIS  ON THE MAP FOR THE INDIVIDUAL INVESTOR.
Would telling you the whole story about investing in municipal bonds, and  making sure you know the risks involved, kill the sale?  “I’ll take my chances,” says Jim (Municipal Bonds Are My Babies) Lebenthal.
 For 45 years, Jim Lebenthal wrote and starred in the Lebenthal family’s municipal bond business commercials -  information nuggets that educated the public and turned munis into a household word, wherever his face and voice were seen and heard.
Outraged by what Wall Street had done to the financial markets with reckless abandon, and Bernie Madoff with malice aforethought, Jim gives equal time in Lebenthal On Munis…Deciding, "Yes…" or "No!" to the Whys and Why Nots for investing in his "babies."
"Balancing the heady appeal of tax exemption with the payment record of municipal bonds in the Depression and the volatility of resale prices during the inflation tortured '70s and '80s, isn’t optional for a broker," says Lebenthal.  "Full Disclosure is the law."
In Lebenthal on Munis, Jim carries out that law, even if Full Disclosure means turning Jim and his babies, thumbs down.
DECIDING, "YES…" OR "NO!"

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The Fundamentals of Municipal Bonds, 5th Edition

Praise for the Classic Guide to the Bond Market

"This is simply the most comprehensive, useful look-it-up book on municipal bonds I've ever read (said with all due respect to The ABC of Municipal Bonds my dad wrote in 1937 when I was nine). Read Fundamentals cover to cover. I'm keeping mine in my briefcase, under my arm, at my fingertips. No accountant, financial advisor, attorney, new bond salesman, reporter, regulator, test-writer, cautious, suspicious first-time investor in municipal bonds, or dinner guest is ever going to catch me again with a question about municipal bonds I can't answer."-Jim Lebenthal, Chairman, Lebenthal & Co.

"Judy Wesalo Temel gives us the Rosetta stone of the municipal bond market, the key to unraveling the many mysteries of 'muni's.' Her book, a fresh take on the old standard Fundamentals of Municipal Bonds, updates chapter and verse on everything from investing to underwriting, from over-the-counter to over-the-Internet. The style is clean, crisp, and as simple as this complex subject can be. Are you a novice who wonders how to invest in bonds? She lays out the basics. Examples are easy to follow-even the mathematical ones that are critical to explaining how municipal bonds work. At the same time, there is plenty of meat for the pros. Whether you need to start from square one and learn all about municipal bonds and how they work, or need a ready reference for specific technical questions you run across as a market professional, this book is for you."-Kathleen Hays, Economics Editor, Credit Markets Reporter, and "Bond Belle" CNBC

"This is a must-read for every scholar, banker, and public official concerned with local government finance in the United States. Judy Wesalo Temel has done the impossible: she has clearly and insightfully explained how we finance the development of the nation's vital public infrastructure. This is an important book, one that will be required reading for professionals responsible for planning, designing, and evaluating publicly financed projects-the health care, transportation, and educational facilities that all citizens rely upon. The bond market is an essential element in the life of local and state government, and this book makes it understandable to all Americans."-Mitchell Moss, Henry Hart Rice Professor of Urban Planning and Director, Taub Urban Research Center, Robert F. Wagner Graduate School of Public Service, New York University

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Tax Free Income With Municipal Bonds

After the past year of massive turmoil in the economy and the markets, investors are wondering where they can invest that is relatively safe and smart and provide a higher return than cash. Tax-free municipal bonds can provide some stability and a reasonable after-tax return for many investor portfolios. It is a virtual certainty that income tax rates will be going up (especially for the "rich") over the next few years to pay for all the huge government borrowing and spending that is going on right now. Social security and Medicare also need increased "funding" from tax revenues. Increasing income tax rates make tax-free municipal bonds more attractive relative to other investments. Historically Muni's have performed well during periods of rising tax rates. Municipal bonds appear attractive relative to US treasury bonds and cash right now because they offer higher yields, lower taxes, and only slightly higher risk (depending on the state) in my opinion.

Muni Bond Investing Basics

Credit risk.

How safe is the state or municipality that is standing behind the bonds? My advice right now with all the municipal budget shortfalls is to stick with safer credits and higher rated bonds. General obligation (GO) bonds are usually safer than revenue bonds because they have the full taxing authority of the state behind them. California is currently having trouble and is issuing IOU's rather than paying their debts.

Interest rate risk.

Bond prices move in the opposite direction of interest rates. How much your bond price will go up or down is directly related to how long the term of the bond is. Long-term bonds (10-20 years) are much more volatile (risky) than shorter term bonds (1-5 years). I recommend sticking with the relatively safer short-term or intermediate term bonds. Generally the more credit risk and the longer the maturities of the bonds you hold, the higher the yield on the bonds. Higher risk=higher yield.

Is It All Tax-Free?

If you buy a national muni bond fund your interest income will be free of federal income taxes (but not state income taxes). If you buy a state muni bond fund that owns bonds from your home state this interest income will likely be "double-tax free" for both federal and state income tax.

Your Income Tax Rate?

Muni bonds make more sense if you are in a high tax bracket. If you are in a low income tax bracket you may be better off (after taxes) owning taxable bonds. Right now muni bond yields are very attractive relative to taxable bond yields so that muni bonds make sense for investors even in some of the lower tax brackets.

Where Should I Own Them?

Muni bonds should be owned in your taxable brokerage accounts, and not in your IRA or 401K accounts because income in those accounts is already tax-deferred.

Tax-Equivalent Yield? What's that?

To compare the yield on a muni bond to a taxable bond you take the muni bond yield and divide it by the inverse of your marginal tax rate. If your muni bond yield is 3% and you have a 40% marginal tax rate then the tax-equivalent yield is 3%/(1-.4) = 5%. That 5% is your tax-equivalent yield and that is the rate required on a taxable bond to beat your 3% muni bond yield.

Should I buy individual bonds or a muni bond fund?

The benefits of investing directly in individual muni bonds is that you can avoid the fund expense ratio and can pick and choose which states, maturities, and credits you want. You can create your own customized muni bond portfolio and can ladder the maturities if you wish. The advantage of buying muni bonds in a fund is that you get professional management, increased diversification, and a simpler and easier investment process for you. For most investors who are not bond experts using a muni bond fund will likely be best. What are some low-cost muni bond fund options?

Fidelity Minnesota Muni Bond Fund (FIMIX)- For Minnesota Residents Only

This is a 4-star rated mutual fund at Morningstar. It is a double tax-free fund (federal and state) for Minnesota residents. The average maturity of the bonds in the fund is 7.1 years and the average duration is 6.5 years. 70% of the bonds are rated AA or better (the top 2 credit ratings). Over the past 1, 3 and 5 year time periods this fund has ranked in the top 10% of its competitors in this category according to Morningstar.

I-Shares National Muni Bond Fund ETF (MUB)

This is a national muni bond exchange traded fund (ETF), so it is only tax-free for federal income taxes. The expense ratio is a low .25% and the fund holds over 375 different bond positions. 83% of the fund is invested in bonds rated AA or higher. The average duration of the fund is 7.5 years.

SPDR Barclays Short-Term Muni Bonds Fund ETF (SHM)

This is a national muni short term bond fund. It is shorter term and safer. The average duration of the fund is only 2.9 years and 100% of the bonds are rated AA or higher. The expense ratio is only .20%.

Keith Tufte
President
Longview Wealth Management, LLC.
http://www.longviewwealth.com