What's the best way to buy municipal bonds? Should I buy single bonds or mutual funds?
Like most decisions, there are pros & cons with both methods. You should talk with you advisor about which method is right for you - possibly a mix of both.
One of the advantages of owning a single bond is that you have a fixed rate of return - you know exactly what you are getting. For example, on a $100,000 muni bond paying a 5% coupon, you will get $5000 per year in interest income. Because you don't have to pay federal taxes and you may not need to pay state taxes, that may be similar to getting 7% or more, depending on your tax bracket.
Interest from a single bond is usually paid ever; 6 months, so you would get $2500 with each installment. You may also ask your advisor to structure your bonds in such a way that you are able to receive income every month.
Another advantage it that while your advisor does get paid, his or her commission is built into the price of the bond when you buy it. This is a common question I am asked.
Think of buying soup at your local grocery store. The grocer buys soup in large bulk quantities, with all brand names & flavors. Because they buy so much soup at once, they can buy at a wholesale price. When a customer buys soup, they pay a retail price and may only buy 1 can, or a few cans at a time.
Bonds work the same way. If you buy a bond worth $10000, you will get $10000 when it comes due. Along the way, you have gotten a great tax free rate of return every 6 months. If you are fortunate enough to be working with a great advisor, you may have even been able to buy the bond at a discount, so that when it does come due, you even had a small gain. (Woo-Hoo!)
Its great when everyone wins!
One more thing about a single bond - You know exactly which project you are supporting.
(Example - St. Joseph Regional Medical Center Bond)
A big disadvantage is that a single bond is not diversified. This is where mutual funds are better. Going back to the "soup" example, a mutual fund allows you to carry all the "flavors" in one investment, which is managed by professionals at a mutual fund family.
Most bond mutual funds also pay interest monthly, because they own hundreds of bonds. This can be helpful if you are counting on monthly income from your investments, and a huge advantage over CDs.
Also, it is much easier to invest a smaller amount. For those who don't have the 5000 or 10000 minimums required by many single bonds, you can establish a mutual fund for as little as 1000.
Once you have a fund, you can add to it or even withdraw money easily.
Sales charges on bond funds purchased through your advisor may be as high as 4.25%, although you may qualify for volume discounts, also known as "breakpoints" if you are able to invest large amounts of money.
For more information on municipal bonds or other investing, please contact me at www.deanvoelker.com