Bonds are known as low-risk options that pay out less money. This simple way of thinking about bonds doesn’t take into account the many different kinds of bonds that are available. Treasury bonds are safe and have low-interest rates. Some city loans have higher interest rates and payoffs.
Find out how these bonds have done in the past to decide if they are a good place to put your money. You should also find out about the risks that come with investments like these.
Risk of Interest Rates on Municipal Bonds
When it comes to the risk of rising interest rates, you can see that local bonds do about the same as the rest of the bond market. In 1994, 1999, and 2013, when the Bloomberg (formerly Barclays) Aggregate Index fell, rates went up in two of those years. In all three, municipals had a negative return at the end. On the other hand, these bonds had a positive return in 22 of the 23 years when the bond market was positive or stable at the end of the year.
Note
Even though local bonds may go up and down more than many other fixed-income investments, they are still connected to the bond market as a whole.
The credit risk of municipal bonds
The profits on local bonds are also affected by credit risk. Credit risk is the chance that a bond won’t pay back its debt. It looks at bigger things that change the prospects for settings. For example, the chance of bankruptcies goes up when the economy gets worse. This can hurt bonds whose credit risk depends on how well they do. Municipal bonds can be issued by a wide range of organizations, including states, big cities, small towns, and even airports and water districts. Because of this, the way they do things can also be affected by credit risk.
Rates went down in 2008, and the bond market went up by more than 5%, but local bonds went down. It shows the year that a slump began. At that time, people who spent their money tried to avoid taking chances. When the home market crashed, towns and other organizations got a lot less tax money. At that point, people started to worry that the number of people who didn’t pay their bills could go up.
Note
Credit risk is something that investors in municipal bonds have to pay more attention to than investors in Treasury bills.
Municipals also didn’t do well in years when there was a lot of money-related news: 1994 (the bankruptcy of Orange County, California); 2010 (Meredith Whitney’s warning of a “wave of defaults”); and 2013 (the bankruptcy of Detroit and the financial problems in Puerto Rico). The effects of these events also show that the performance of local bonds depends on more than just the direction of interest rates.
Over the long term, the profits on municipal bonds have been pretty close to those on the investment-grade market. Remember that this is not a fair comparison because the interest on local bonds is not taxed. Because of this, after taxes, the total return on local bonds is closer to that of investment-grade bonds than it seems at first.
In conclusion
People often say that bonds give conservative buyers and people close to or in retirement the low-risk profits they need. With a difference of almost 20 points between the best and worst years. They go up and down less than stocks, but there is still a chance that they will go in wild directions. And just like with stocks, when you start spending is very important.
Note
Even though municipal bonds have been less up and down than stocks, they’re still a pretty risky place to put your money.
Bond profits were very high at the beginning of the 1980s. This happened because the people who put their money in bonds got a head start that most new buyers couldn’t match. In the same way, people who put their money in bonds after the meltdown started in 2007 have seen low results for nearly a decade. Even if interest rates go up again, that won’t make up for how slow things have been so far.
Questions Most Often Asked (FAQs)
How are taxes paid on city bonds?
Municipal bonds are often tax-free at the federal, state, and local levels, as long as you buy them from producers in your area. You might want to work with a professional to make sure that the bonds you choose can give you tax breaks from state and local governments.
Where can I buy shares from the government?
Depending on where you live, big brokerages may let you buy local bonds (or bond funds) for your state. If your company doesn’t have the right type of city bonds, a full-service broker or investment manager can help you find the investments you want.
