What Is It?
Municipal bonds, or "munis" for short, are debt securities issued by a state, municipality or county to finance its capital expenditures. Such expenditures might include the construction of highways, bridges or schools. Munis are bought for their favorable tax implications and are popular with people in high income tax brackets.

The major advantage to municipal bonds is that many of them are exempt from federal taxes and most are exempt from state and local taxes too, especially if you live in the state that issues the municipal bond. For example, Washington residents can get triple tax savings by buying WA municipal bonds because they pay no federal, state or local income tax on them. For this reason, munis are very popular with wealthy investors because they avoid having to claim the income for tax purposes. (To learn more about munis, see The Basics Of Municipal Bonds and Weighing The Tax Benefits Of Municipal Securities.)

There are two types of municipal debt:

1. Public Purpose - these are bonds used for government projects and are always tax exempt.

2. Private Purpose - slightly different in the sense that they are only tax exempt if it clearly says so, otherwise you are subject to the provisions placed on the bond. (This can vary widely from bond to bond.) These types of munis are called private purpose because they usually fund a project that will benefit both government and a private entity.

Objectives and Risks
For the most part, investors should buy munis for income. While capital appreciation is possible in a falling interest rate environment, this isn't considered a primary objective of munis. When looking at muni quotes, remember that their yield is usually quite low because the tax benefits are usually priced into the bond already.

There are no substantial risks associated with buying a muni - just make sure to research the municipality from which you are purchasing it. For example, a New York muni would probably be a little more creditworthy than one from Puddle Jump, Wyoming.

How To Buy or Sell It

Municipal bonds can be purchased from almost any full-service broker and most discount brokers. Some municipalities also allow you to purchase the bonds directly through them. Minimum investment in a muni can start in the thousands of dollars.

A popular new way to invest in munis is through municipal bond funds, which pool together munis from various states and cities, allowing you to have a well-diversified portfolio while getting all the benefits that you would get purchasing the muni yourself. (For a general introduction to the world of bonds, see our Bond Basics Tutorial.)



Strengths
  • Income from municipal bonds is tax exempt, but capital gains are not.
  • Munis are considered to be very low-risk investments.

  • Weaknesses
  • Municipal bonds in smaller municipalities can sometimes be difficult to sell quickly.

  • Three Main Uses
  • Tax-Exempt Savings
  • Provides Income
  • Protects Principal

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