This blog isn't a primer on municipal securities (munis). The Securities and Exchange Commission website has a one-page overview on municipal securities that covers that ground nicely. Instead, I'm writing about munis as a bond investment for individuals who wouldn't normally consider them and don't have them in their portfolio now.
One reason to consider them is the expected change in the liquidity rules for banks that won't let banks count the municipal securities they own as high quality assets that banks can sell to avoid a liquidity crisis. To the extent that banks sell their munis to replace them with high quality assets, the price of municipal bonds will go down, and their yields will go up. While not popular with banks or municipal issuers, this regulation is expected to be finalized in September.
The heads-up now gives you time to evaluate whether municipal bonds are right for you portfolio, and whether you want to own them as individual bonds, in a mutual fund or in an exchange-traded fund, or ETF.
If you work with a financial services professional, talk to him or her about which approach is best for you. Do-it-yourselfers have to decide whether the control they gain in owning individual issues more than compensates for the lack of professional management and diversification available in a mutual fund or ETF. There are tax issues to consider in the three approaches as well.
Short-dated munis (1 to 5 years) don't offer any yield pickup versus Treasuries. Long-dated munis (10 to 30 years) do offer a nice yield increase on a tax-equivalent basis versus Treasuries. The tax-equivalent yield, or TEY, is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond.
The question is whether the muni yields will move higher, with prices lower, if banks adjust their portfolios. Stay tuned.
Municipal bonds are debt securities issued by state and local governments and other governmental entities to finance capital investment and/or day-to-day obligations. The interest earnings on munis are exempt from federal income tax and may also be exempt from state and local tax as well, typically for residents of the state and locale where the bonds are issued.
For example, New York City munis, when owned by a New York City resident, are exempt from federal, state and city income taxes. Some states don't exempt muni income from their state income tax, so you need to know what taxes are exempt when you buy a municipal bond, municipal bond fund or ETF.
Munis traditionally have lower yields than U.S. Treasuries because of the tax exemption(s). That's true even though munis are considered riskier than Treasury securities. By the way, interest income on Treasury securities is exempt from state and local income taxes but are subject to federal income taxes.
Do you currently have munis in your portfolio? Did this post get you curious about adding munis to your portfolio?
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