Your only sensible investment goal is to maximize overall return while meeting your needs for safety and liquidity. Depending on your particular financial situation, municipals may help you reach your goal.
However, before you buy them, it is important to understand some basic facts.
As a group, municipals are among the safest of investments. They fall into two broad categories: general obligation bonds and revenue bonds.
- General obligation bonds are issued by state and local governments, which borrow money this way to build roads, schools and other facilities.
The issuers pay the interest and eventually pay back the face amount of the bonds out of general tax revenues.
- Revenue bonds are issued by power, sewer, industrial development or other local authorities, which pay the interest and principal out of the income generated by the facilities built with the borrowed money.
Credit experts, such as Moody's and Standard's & Poor's, evaluate the financial condition of all municipal bond issuers and rate their bonds for safety.
Standard & Poor's ratings of A, AA or AAA (or A, Aa, Aaa for Moody's are considered the safest - but these top-rated bonds generally pay the lowest rates of interest. Riskier bonds pay higher interest - in effect, to compensate bond buyers for assuming in the risk.
None of the interest paid to municipal bond investors is subject to federal income tax. If you buy a bond issued in your state, such as Grand River Dam Authority due 6/1/94 with 8.20 percent yield to maturity, the interest typically is exempt from state and local income taxes (called "triple-tax-free").
In addition to weighing the safety factor, you must determine whether a municipal makes financial sense for you. If you are in the 50 percent tax bracket, the arithmetic is simple.
A bond yielding 7 percent is equivalent to a taxable investment yielding twice as much - 14 percent. …