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Monday, April 13, 2009

Tax-Free Bonds - - Are They Safe?

On Friday, we talked about how a municipal bond can pay higher interest then a CD, and its even better when you consider you don't pay Federal taxes on the interest you earn. You may also be free from State & Local taxes depending on where you live, and where the bond(s) was issued.

A common question which I am asked is - "How safe are they?"

Muni bonds are very safe investments. They are backed by the taxing power of the state which issued the bond. Bonds are given ratings based on the credit quality of the issuer.

AAA - Very High Credit Quality
AA - High Quality
A - Good Quality
BBB - Investment Grade (still a safe investment)

For obvious reasons, I would not advise buying bonds with less than a BBB rating. For my clients, I generally prefer at least an A rating or above.

When we say 'safe', it means that you should have a reasonable expectation of receiving your interest payments on time and also receiving your principal investment repaid on time. Think of your car. When you go to start your car, you would have a reasonable expectation that it would start when you turn the key.

On the very slim chance it didn't, of course you would take steps (i.e. jump start, battery change) if needed to get it started, and return to having a 'reasonable expectation' for it to start when you need it. Bonds work much the same way, even if you are worried about the ability of a certain state to repay its loan, the state may simply levy a tax to pay back the bond.

You can also buy muni bonds which are insured for that extra layer of safety. Common insurers are MBIA (Municipal Bond Insurance Association), AMBAC (American Municipal Bond Assurance Corporation), and FSA (Financial Security Assurance) .

Tomorrow, we can talk about the 2 main ways to buy muni bonds - individual bonds or mutual funds.

For more information on muni bonds, you may contact me at .

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