What are the Risks Municipal Bonds and Funds?

Although the risks associated with municipal bonds and funds are minimal, they do exist.

• Credit Risk - An issuer may default in making interest payments and may also claim inability to pay back the principal amount. Hence, it is very important to check on the evaluations of rating agencies on the creditworthiness of the issuers. If the rating is BBB or BAA or better, then the issuer has a good track record. If the rating is below, then, whether the municipal bond is backed by insurance policies in case of a default needs to be checked out.
• Interest-rate Risk - The interest rates of a municipal bond are fixed, so if the interest rates in the market go up, you do not stand to gain from it. You will continue to have the same interest amount, which would be lower compared to the other existing, high yielding rates.
• Lower interest rates - Since the interest amount is tax-exempt, the interest rates are considerably lower than the taxable bonds. Hence, it may be more beneficial to invest in taxable bonds under certain circumstances where a decrease in income tax is expected.
• Call Risk - An issuer can repay the entire or part of the bond amount before the maturity date. If this is done, although you would get back your principal amount along with a premium to compensate for the early repayment, your income through the interest terminates immediately.
• Market risk - Market conditions determine the underlying value of your bond. If the market interest rates fall, then the Municipal Bond new issue has a considerably lower yield compared to the older bonds. If the interest rates go up, then the older bonds have lesser value than the newly issued bonds. This is, of course, a cause for concern only if you are planning to sell your bond before maturity date. Then market condition will determine whether you have made a profit or a loss through your transaction.

Is Municipal Bond the Right Choice for You?

To decide on whether investing in municipal bonds is the right choice for you, you need an understanding of municipal bonds. You also need to consider your investment objectives, your income bracket, and the availability of choices. Other questions that need to be considered are: Who is responsible for the interest payments on the bonds? What is the creditworthiness and economic background of the issuer? You need to analyze the credit ratings that have been given to the issuer by credit agencies. To help you to do this, the services of a municipal bond broker may be necessary. Brokers will do the research needed for you to invest wisely.

If you are looking for low risks, steady returns, and safekeeping of capital, then tax-free municipal bonds investments may be the right choice for you.