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Tax Free Municipal Bonds - It Could Suit Your Portfolio Perfectly!

Tax Free Municipal Bonds are debt obligations or IOUs that are issued by the state, county, city, or any other political sub-division to individuals who have lent money for community projects such as building a school, hospital, or road.
These bonds are attractive to individual investors, since, as the name indicates, the government does not tax the interest received. When you invest in buying a municipal bond, you are loaning money to the issuer for a fixed number of interest payments over a certain period. At the end of that period, the bond has matured, and you will get back the full amount of your original investment.

What are the Characteristics of Municipal Bonds?

The chief characteristic of Municipal Bonds, or Munis as they are called, is the tax-free interest that the investor receives. These 'bank-qualified new issue municipal bonds/bank qualified municipal bonds' or 'qualified tax-exempt obligation' depends on who the issuer of the bond is and what type of bond is being issued.

There are primarily two types of municipal bonds:
  • The General Obligation [GO] bond is issued by a body that has the power to tax. So the interest on the municipal bond funds come from the payment of other taxes the issuer receives. These bonds are issued to raise immediate capital to fund community projects.
  • The Revenue Bond is issued by businesses that work on infrastructure projects and the interest paid is actually the revenue earned from these projects themselves. So the success of this bond depends on how profitable the project turns out to be.
Benjamin Graham states that a municipal bond must have
  • a population of 10,000 or greater
  • a diverse economy
  • a history of punctual payment on past obligations

What are the Benefits of Municipal Bonds?

  • Tax-Free income - When you invest in a municipal bond, you do not pay taxes on the interest you receive. Not only is the interest payment free from federal taxes, but also, if the issuer of the bond is in your state then the interest is exempt from state and other local taxes.
  • Preservation of Capital - After the regular payment of interest payments over a period of time, when the bond reaches maturity, you will get back the original investment amount. So, your capital has been in safe keeping as well as earning you revenue over a period of time in the form of interest.
  • Stability - Understanding Municipal Bonds Investments are the safest form of the different types of investment. The capital that you have invested in used for public enterprise and not for private projects, so risks are minimal. Also, in interest payments, the general obligation bonds are particularly safe as they are guaranteed by the other taxes received by the bond issuer.
  • Community welfare - Besides financial benefits, you play a worthwhile role in your community by investing money in municipal bonds new issue funds that are used for community projects.
Continue to: Risks with Municipal Bonds and Funds
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