An improving economy generally means higher interest rates, and higher interest rates typically cause bond prices to fall. But that doesn’t mean you should avoid bonds altogether. The key is to select bonds that tend to not be as affected by interest rates as many others.
Municipal bonds are one option, depending on your individual financial situation. A municipal bond is a debt security issued by a state or local government or governmental entity, typically to raise money for building roads, schools, etc. The interest is usually exempt from federal income taxes. Bonds issued by the state in which you live are generally exempt from state taxes as well.
The tax advantages are why investors with high income levels have traditionally sought municipal bonds or bond funds. Although the actual yield may be lower than on a taxable investment, the “tax-equivalent yield” (the yield after you’ve factored in the fact that you aren’t taxed on the bond’s interest) may actually be higher. For example, assuming a combined 38% state and federal tax rate, a 4.15% yield on a 10-year municipal bond is equivalent to a 6.69% tax-equivalent yield.
But there are several other reasons to buy municipal bonds. Municipal bonds may not be as volatile as other fixed-income investments. Additionally, a strengthening economy, which typically accompanies an interest rate hike, can improve issuers’ financial health and bolster municipal bonds.
If you think municipal bonds might be right for you, we can help you select them, so please call or email us. We’re here for you.