Buying municipal bonds

Terry Says

Municipal bonds are attractive because the interest you earn is free from Federal taxes, andmay be free from state and city taxes as well.   If you’re in the top tax bracket that certainly has an appeal.  But there are a few things you should know before buying munis.

First, Tax-free municipal bonds bear the same risks as other bonds.  When interest rates go up, bond prices go down!  So if you expect rising interest rates, don’t buy any bonds.

The second issue is picking bonds — Yes, there are ratings to determine safety.  But are you really sure you want to be lending to a specific state or municipal government.  In a recession, what happens if they can’t collect  enough taxes to pay the promised interest?

There’s another problem with buying individual municipal bonds.  You never know when you’re getting a good price on the purchase or sale.  Muni bonds trade infrequently.  Often, they are priced to include a big commission for the broker.

For this reason, if you want to buy muni bonds, I suggest a fund managed by Vanguard or Fidelity, which guarantees you’ll get good quality and realistic pricing. Stick with funds that buy  no longer than 10 years munis of reasonably high quality.