Recent market turmoil has made many investors understandably nervous, but it has also created opportunities. Municipal bond funds, for example, may be appealing right now.
Municipal bonds are issued by governments (both state and local) and their agencies, such as counties, cities, schools, and water districts. They are used to finance public projects, such as schools and airports, and some private projects, such as nursing homes and toll roads. Municipal bonds are widely available via mutual funds.
Investors have traditionally purchased municipal bonds for two reasons. First, like all bonds, they may offer a measure of diversification and stability when equity markets are volatile. That is because increased equity market volatility causes bond yields to move higher and prices lower.
Second, municipal bonds offer potential tax-free income. You do not pay federal taxes on municipal bond interest. The interest may also be exempt from state and local taxes because most states do not require their residents to pay state and local taxes on interest received from bonds issued by governmental entities within their states. This may be the greatest appeal of municipal bonds.
One thing to keep in mind is that no investment is entirely immune from market volatility. While the overall default rate on rated municipal bonds is low, municipal bonds have certainly been affected by market volatility surrounding the COVID-19 pandemic. There are concerns about the longer-term effect a severe slowdown in economic activity could have on municipalities’ finances.
As a result, selecting the right municipal bond is of paramount importance. First, you should seek municipal bonds that are rated. Second, some municipal bonds are insured, offering greater safety. Third, you also want to choose a municipal bond that carries an appealing maturity.
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