One of the most tax efficient kinds of income investments -- and we all should want to pay as little taxes as possible -- are municipal bonds.
These are bonds issued by state and local governments to raise money (taxes aren't enough!). Many investors like to buy them because they are not taxable at the federal government.
Some states with high tax rates (especially California and New York) don't tax municipal bond interest from within those particular states. Thus, many wealthy people living in those states invest all their money into municipal bonds issued within those states. That saves them from paying both federal and state taxes.
Will We Have to Bailout Municipal Governments Next?
Recently some experts have indicated that these may be the next big "domino" in the financial crisis. That's partly because some of them have been involved with various kinds of derivatives.
It's partly because tax revenues are down because of the recession. And financial hard times also puts greater strain on public services.
Historically, muni bonds have proven quite safe. State and local governments do have the power to raise income through taxation, though that's somewhat limited by the power of people to object and vote out elected officials.
Some Local Governments Have Defaulted on Their Bonds
There have been some prominent failures of municipal bonds: an issue in Washington state that was supposed to finance nuclear power plants, Orange County California and a few others.
The video with this article discusses the most recent example of Jefferson County Alabama, which dabbled in derivatives and got burned early in 2008.
This expert knows the market well, and believes it's still generally reliable.
Finance Water Pipes Before Skating Rinks
He advises that the general obligation (GO) bonds and bonds issued for specific, important functions are the safest. The farther away bonds are from financing essential parts of the government, the riskier they are.
His general belief seems to have been validated. This video dates back to 2008, when people were (understandably) worried about what would happen next in the financial crisis.
The Sky Hasn't Fallen -- Yet
It's now two years later as I write, and there has been no mass bankruptcies of municipalities and county governments. That doesn't mean it won't happen, but it no longer seems as likely as it did in 2008, unless you're a chronic doom and gloomer.
There are Risks and Expenses to Buying Municipal Bonds
Unfortunately, however, buying individual municipal bonds is both risky and expenses. Buying municipal bond mutual funds is too expensive. The best way is through Exchange Traded Funds, such as the iShares S&P National Municipal Bond Fund ETF (MUB).
There are also muni bond ETFs that specialize in California and New York municipal bonds. If you live in one of those two states, I advise you to check those out.
The rest of us need as much diversification as possible, so MUB is good for that. Unfortunately, I don't know of any fund that concentrates on the least risky bonds as outlined by the expert in the video.
Also, you should not own municipal bonds in a tax-deferred retirement account. That's because the income they generate is already nontaxable.
You should own a diverse number of income investments in your portfolio, and municipal bonds deserve a place there.
Author Resource:
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