A new era in buying and selling municipal bonds started this week. FINRA, the securities industry self-regulatory agency announced it will require brokers who buy and sell municipal bonds to individual customers to reveal their “markup” or commissions, which are built into the price of the bond.
Sales confirmations for bond purchases and sales will now reveal the exact dollar amount and percentage of the prevailing price that was charged to the customer. Until now, a buyer (or seller) of a small amount of bonds received a confirmation stating only the total purchase price to be paid, or the total sales price that would be credited to the account.
It may have appeared to unsophisticated customers that no commission was charged. But that commission was “built in” to the price of the transaction. And, unlike stocks which have prices traded and posted throughout the day, municipal bond transaction prices are not posted publicly, making it difficult to see if the price was fair. Brokers often marked up the purchase price by several percentage points, costing the customer a lot of money. Or they quoted lower prices when they sold the bonds, pocketing the difference.
The new revelations will be costly the brokerage industry, as customers push back on paying exorbitant prices when they see the built-in commissions that are profits to the broker.
The Tax-Free Attraction of Municipal Bonds
There’s no denying the appeal of tax-free interest offered by municipal bonds – especially when priced fairly. So, let’s start with some basics. Municipal bonds are sold by states, cities, municipalities, and other governmental taxing bodies to raise money for various purposes. The tax law gives the municipal issuer an advantage in raising money, by allowing interest earned on the bonds to be free from federal taxes (and typically free from state and city income taxes to residents of those localities).
Some bonds are guaranteed by the general revenues of the city or state; others guarantee the interest and repayment of principal from the revenues of a specific project, such as a water district or even a sports stadium. Obviously the credit quality of the issuer is critical, and most bonds are credit “rated” by companies including Standard & Poor’s, or A. M. Best.
Since tax-free income is highly desired by investors – especially those in higher tax brackets — municipal bonds yield slightly less than comparably rated corporate bonds of the same quality and maturity. It’s the after-tax comparison that counts.
How to Buy Municipal Bonds
It has been difficult for an individual investor to get a good deal on buying municipal bonds. There is a municipal bond pricing website called EMMA — created by the Municipal Securities Rulemaking Board. There you can search for bonds by state, and issuers within the state. You can see the ratings, interest coupon, and maturity date of all issued municipal securities. And, you can check on the latest prices of recent trades in these bonds, though many trade infrequently.
It is for that reason, I have always advised individual to purchase mutual funds that invest in these bonds. The fund traders know – and get –the best prices on both the buy and sell side of the transaction. There are a variety of muni bond funds, specializing in short or longer term maturities, or higher or lower quality bond investments. And there are muni bond ETFs, containing fixed packages of tax-free bonds.
You can buy muni bond funds without paying commission, by going directly to Vanguard, Fidelity, T. Rowe Price or other major mutual fund companies. If you buy the funds through a stockbroker, you will be charged an up-front commission.
But now the game has changed a bit for those who choose to buy individual municipal bonds. The disclosure of markups means you’ll likely get a far better price when you buy or sell municipal bonds. Plus, you’ll know what you paid to do it. And that’s The Savage Truth.