What You Need to Know About Investing in Municipal Bonds
Municipal bonds are the only sector of the bond market where the primary buyers are individual investors. The chief attraction of munis is that they are exempt from federal taxes. If you are a resident of the state issuing the bonds, they are also exempt from state taxes.
Overwhelmingly, munis deserve their popularity among individual investors. Even though there are thousands of issues outstanding, munis are sound and relatively uncomplicated instruments. Nonetheless, buying individual municipal bonds is not quite as simple as buying Treasuries. The buyer of municipal bonds must be aware of a number of issues: The first one is whether or not you would earn more by buying munis than by buying taxable bonds; second, you need to understand credit quality; and finally, commission costs can be high—particularly if you need to sell a bond before it matures. However, commission costs are hidden.
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No one likes to pay taxes. But it does not always pay to buy tax-exempt bonds rather than taxable bonds.
If you are considering buying munis, your first step should be to determine whether you will earn more by buying munis or by buying taxable instruments. The method used most often is to calculate how much you would have to earn on taxable investments to earn as much as you net on municipal bonds. This is called the taxable-equivalent yield.
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