What are Municipal Bonds

When looking for tax free investments every investor will eventually come upon municipal bonds. Of course the same investors are going to wonder just what municipal bonds are. Municipal bonds are bonds issued by state and local governments to pay for various government projects. The funds for that new bridge where probably acquired through an issue of municipal bonds.

In most cases municipal bonds are free from federal and state taxes. If you live in a city with a local tax, and purchase municipal bonds issued by that city, they are generally tax free as well. Since the municipal bonds carry a tax advantage they can be beneficial for investors whose primary accounts are taxable.

Generally municipal bonds pay less interest than taxable bonds. As such is the case when purchasing bonds for a portfolio you need to consider your overall tax rate. Comparing your after tax yield on taxable bonds and the yield on municipal bonds will allow you to purchase the best type of bonds for your situation.

Municipal bonds have a default risk just like there taxable counterparts. In many cases municipal bond issues carry insurance that promise to cover the principal and interest should the issuer default. However, such promises are only as good as the insurer’s financial situation. When purchasing municipal bonds you should use a municipal bond index fund like those available through Vanguard. Doing such will allow you to be diversified and limit risk as much as possible. Hopefully you can now answer the question, “What are municipal bonds?”