How to Buy Municipal Bonds (Good Investments?) | Where to Buy Municipal Bonds
Are municipal bonds are a good investment to include in any portfolio to ensure adequate diversification.
If you are wondering how to buy municipal bonds or where to buy municipal bonds, this overview can answer those questions for you. Plus, knowing the risks to consider before investing in municipal bonds will help you make a wise investment.
Municipal securities are a $3.7 trillion market, according to the MSRB (Municipal Securities Rulemaking Board) Education Center. Before learning how and where to buy municipal bonds, you will want to understand exactly what one is and how it works. Municipal securities, including municipal bonds, help finance public projects like:
- Schools and universities
- Airports
- Hospitals
- Road work
- Water systems
- Sewer systems
- Bridges
- Libraries
The state or local government issues the municipal bonds to financial advisors. These professionals, such as brokers, work with investors to help fund the community’s projects.
These investors receive interest payments, and when the bond reaches maturity, the investors should receive the total amount of the municipal bond.
The municipal bonds are tax-free on the federal level and, in many cases, on the state and local level if the investor resides in the same area as the issuer. Communities and government have been working together through municipal bonds for over 200 years, and the municipal securities market continues to grow.
Whether you are investing in municipal bonds for the first time or wondering if municipal bonds are a good investment, you have access to over 50,000 issuing city, county, and state governments in a less volatile market.
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Where to Buy Municipal Bonds (Investing in Municipal Bonds)
You can buy municipal bonds through the issuer’s broker or brokerage firm that is underwriting the security offering. You may be able to purchase a secondary market municipal bond from another investor through a brokerage firm, online brokerage, or bank.
When it comes to buying municipal bonds, there are two types. These include general obligation bonds and revenue bonds. General obligation bonds are issued by the state or local government and are repaid through tax revenues, like personal property tax, and other available resources. The issuers are typically states, cities, and school districts. If the issuer falls behind on payments to the investor, then they must sell assets, raise taxes, or find another way to raise the funds to make the interest payments or pay the principal balance.
The repayment for revenue bonds does not come from increased taxation, but from the revenue issuers receive. The typical issuers of revenue bonds are water systems, sewer systems, transportation authorities, and hospitals. Although utility companies can plan for rate hikes to repay revenue bonds, hospitals may find it difficult to increase revenue for repayment.
The Electronic Municipal Market Access website, also known as EMMA, can help you find out more about available bonds and their issuers. This site helps you find trade prices, disclosures, statistics, and other information you need to make a wise decision and monitor your bonds. You can search for bonds within your state, county, and city when buying municipal bonds. Not only can you manage your portfolio of municipal bonds using EMMA, but all of your municipal securities, like 529 College Savings Plans.
How to Buy Municipal Bonds (Investing in Municipal Bonds)
The MSRB lists four ways you can buy municipal bonds, and these are largely based on your preference, although you should consider whether or not you plan to trade often and your monetary resources. These choices include:
- Look for a municipal securities dealer at your local bank or use a brokerage firm.
- Find a personal investment advisor.
- Sign up for an online broker or trading platform for self-service.
- Buy (or sell) shares through an exchange-traded fund (ETF).
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Municipal Securities Broker-Dealers (Buying Municipal Bonds)
You can find broker-dealers at your local bank if they have a municipal securities department, or you can use a brokerage firm. The broker-dealer can sit down with you and explain the details, risks, disclosures, and even make recommendations, but cannot buy or sell any shares unless you tell them. Due to legalities, broker-dealers must charge you fair prices and disclose all pertinent information before transactions.
While buying municipal bonds, a broker-dealer can recommend the best municipal bonds for your circumstance and investment portfolio based on the risk involved. The MSRB reminds consumers and investors that once the broker-dealer explains the disclosures to you, all buying of municipal bonds and selling of shares is ultimately your decision.
An advantage of using the services of a brokerage firm or broker-dealer is that these people usually have the inside news on new municipal bonds and other securities from both government entities and individual investors. The broker-dealer will charge a fee, which could be a commission, mark-up fee, or mark-down fee, depending on the transaction.
If you are buying municipal bonds and using the broker-dealer as an agent to handle the transaction on your behalf, then the fee charged is a commission. However, if the broker-dealer has the municipal bond in their inventory, even for a short time period, then a mark-up fee is charged. A mark-down fee is charged when the broker-dealer sells you shares from his or her inventory. You may pay additional transaction fees as well.
You can check the trading history of the municipal bond on EMMA to confirm you are receiving a fair price. If the trading history is not available, try using the site’s Price Discovery Tool. It will allow you to compare trade prices of other similar municipal bonds.
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Personal Registered Investment Advisors (Buying Municipal Bonds)
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A registered investment advisor (RIA) can represent you in business dealings, including buying municipal bonds. An RIA is registered with the Securities and Exchange Commission (SEC). Confirm that your RIA is also registered in your state. As a precaution, you can use the database on the SEC’s website to check your RIA’s background and registration status before hiring them.
An RIA must display fiduciary duty. This means the advisor must act with your best interests in mind at all times. The MSRB suggests requesting the investment policy and the investment process in writing. Your paperwork should clarify how the RIA will charge you as this can vary between advisors.
The following is a list of fees you may see from your RIA:
- Management fees
- Annual percentage based on your assets
- Delivery of trade fees
- Trade processing fees
- Consultation fees
RIAs may work for a company and become affiliated with broker-dealers they will use for buying municipal bonds on your behalf.
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Online Brokerage Platforms (Buying Municipal Bonds Directly)
If you tend to understand the disclosures, statistics, and risks for investing in municipal bonds easily, then consider buying municipal bonds directly without the service of an advisor. You can open a self-managed account with certain online brokerages that serve as municipal securities dealers. These companies have electronic disclosures but may not offer one-on-one consultations based on your portfolio needs.
The online broker-dealers charge fees similar to their offline counterparts, including commissions, mark-up fees, and mark-down fees. You will want to research and compare the various fees between companies before opening an account. The larger companies include Charles Schwab, E*TRADE, Fidelity, and TD Ameritrade, just to name a few.
According to the NASDAQ, using an online broker can give you more of a personalized experience when it comes to managing your finances. You can choose where investing in municipal bonds will work for you without relying on a “favored” affiliation between an RIA and broker-dealer.
Another advantage of using an online brokerage firm to buy municipal bonds is the ability to trade 24 hours per day at your convenience. Many companies now have apps available so you can buy municipal bonds directly on the go.
Municipal Bonds through ETFs (Buying Municipal Bonds)
Municipal bond ETFs are federal tax-exempt mutual funds that trade on the stock exchange and occur between investors, not a mutual fund company. These municipal bond ETFs trade during the day until the exchange closes, so they can be quickly liquidated, if needed.
MSRB suggests that municipal bond ETFs may be volatile due to the fact that the securities trade like a stock and the price per share may not match the net asset value (NAV) of the ETF. There is also a low rate of interest for these particular ETFs that may not yield enough to make the investment worthwhile to your portfolio — unless you have tax reasons for doing so.
Due to the Alternative Minimum Tax (AMT), you may have to pay tax on some of the interest you receive from the issuer if you receive more than the limit allowed for municipal bond interest. Typically, upper-income investors are affected, but more and more middle-upper-income families are falling into the AMT bracket. Consider speaking with a financial advisor or tax accountant to see if the interest you receive from your municipal bond ETFs will be subject to AMT.
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Are Municipal Bonds a Good Investment? Considering the Risks When Investing in Municipal Bonds
Although investing in municipal bonds is seen as a wise investment, since utility companies and governments can usually pay interest payments and the principal fairly easily, there are a few risks you should take into consideration before buying municipal bonds:
Default risk – Just like with individuals, issuers are evaluated for their creditworthiness to repay debts. As an investor, you need to know the credit risk of the issuer to anticipate timely interest payments as well as the principal payment at maturity. If the issuer is a state or local government entity, their updated financial records should be disclosed to potential investors. Many issuers offer event notices that detail past due interest, principal payments, and other financial transactions.
You can use the EMMA website through MSRB to check out the ratings for a particular issuer. You can find ratings on the site assigned by Moody’s Investors Service, Standard and Poor’s, Fitch Ratings, and more.
Interest rate risk – The price or market value of a municipal bond can be affected by interest rates. As the interest rates fluctuate, the investor may not receive the full bond value if they try to sell, especially when interest rates rise. When interest rates fall, an investor may receive more than the value during a secondary market sale.
Numbers are assigned to municipal bonds to give the investor an idea of the bond’s interest rate risk. This is called duration. MSRB explains that the duration number assigned is comparable to a one percent change in interest rates, increase or decrease. For example, if the duration of a bond is 5, then for each one percent increase in interest rates, the price of the municipal bond will decrease by five percent.
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