Municipal bonds offer a relatively safe and tax-free investment
An information booklet says they ''dig roads, build schools, lay sewers, light streets, put up hospitals, remove slums, rebuild housing, move commuters, pave runways, provide energy, create parks, clean up the air, drain swamps. . . .''
This is not a crew of hard-working superheroes, but an old investment vehicle getting some renewed attention lately: municipal bonds.
Since interest rates started going down this past summer, state and local governments and their agencies have been issuing municipal bonds at a furious pace. Last year, says Stephen Hueglin, partner with Gabriele, Hueglin & Cashman Inc., a New York bond brokerage, about $45 billion in ''munis'' were issued. So far this year, bonds are coming out at a $55 billion pace. But since August, Mr. Hueglin says, they have been coming out at a rate of $2 billion a week, or $100 billion on an annual basis.
Hueglin sees two main reasons for the rush to sell municipal bonds. First, ''a lot of issuers have been waiting for interest rates to come down.'' Like a person who puts off buying a car until auto loan rates drop, cities and states have put off all but the most necessary improvement projects until interest rates went down. Then they re-entered the bond market.
The second reason, Hueglin says, can be compared to a person refinancing a home mortgage at a more favorable rate when interest rates drop. Many of the munis coming out now, he notes, are ''refunding bonds'' used to pay off older, high-interest bonds and, perhaps, to make some further improvements.
While bond issuers are finding this a good time to be in the market, there are reasons for increased interest by investors. For one thing, many people who bought All-Savers certificates last year got their first taste of tax-free interest. Now they want to keep that advantage, although All-Savers are paying lower rates and will no longer be available after the end of this year. Interest on municipal bonds is free of all federal taxes. Also, states generally exempt residents from state taxes on their own state or municipal bonds.
Many individuals are also seeking alternatives to money market funds, where yields have been slipping; they are trying to join the ''flight to safety,'' looking for more certain investments in uncertain times.
For a normal minimum of $5,000 (and increments of $1,000 after that), you can get an investment that is not only tax-free, but is backed by the full faith and credit of the issuing government body. Many court rulings over the years have fully established the principle that a municipal-bond obligation is practically set in concrete: once issued, a bond must be paid off as scheduled, even if taxes or fees have to be increased to pay off an old bonding debt.
There is a lot of information available from brokers, books, and newsletters on municipal bonds, and anyone not familiar with them should do some reading before making an investment. One of the best sources of information is the ''Municipal Bond Information Kit,'' published by Lebenthal & Co., a bond brokerage. You can get it for no charge from Lebenthal at One State Street Plaza; New York, N. Y. 10004.
One thing to remember about municipals, says Mark McAvoy, a broker with Lebenthal, is that they are not a one-shot investment. ''People who bought one bond 10 years ago and never bought another one may think it was the worst investment they ever made,'' Mr. McAvoy says.
The best strategy, he believes, is to buy bonds so that they eventually provide a steady stream of income. You can buy bonds with due dates as short as a month and as long as 30 or more years. With coupon bonds, you clip a coupon from it twice a year for the life of the bond. That's your interest. At maturity , you turn in the bond and get its face value. Some bonds also pay face value plus a dividend.
There are two basic types of bonds, distinguished by their source of payment. General-obligation bonds, called GOs, are paid from all taxes and revenues available to the issuer. The issuer also pledges its full faith and credit to paying off the principal and interest. You should ask if the town's cash flow covers all its current operations, or if it using short-term borrowing to cover operating expenses. If cash flow is covering current operation expenses, the bond is probably a safer investment.
Revenue bonds are paid from fees or a specific tax. This may include airport landing fees, bridge and highway tolls, mortgage repayments for housing bonds, or a special school tax. Ask the brokers or issuers how many planes land, how many cars go over the bridge, and how wide the margin is between tolls and the bond payments.
You can also purchase ''notes,'' which are municipal bonds with shorter maturities, ranging from a few months to a few years. These are used for temporary financing in anticipation of new taxes, revenues, or a permanent bond issue.
While most brokers recommend that new investors start out with good-quality, highly rated bonds, too much attention to a top rating can be unnecessarily expensive. You're paying for each additional rating grade, but an A-rated bond may be a better value than one with a AAA rating. Often, the repayment record of the issuer is more important than the rating. Even New York City, which nearly went into default in the 1970s, is paying off all of its bond obligations.
While $5,000 is the usual minimum investment, you often can get ''odd lots'' in municipal bonds that sell at lower prices (higher yield) than the same bonds sold in blocks. And if you want to sell part of your bond portfolio, you can find brokers that will help you. There is a market for odd lots, but not all brokers bother with them.
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