In previous articles, you've learned how to invest in bonds. There are many different types of bonds: corporate bonds, AMT bonds, government bonds, and municipal bonds, just to name a few. In this article, we'll take a look at investing in municipal bonds specifically.
How to Buy Individual Municipal Bonds
You can buy individual municipal bonds through bond dealers, banks, and brokerage firms. In some cases, you can even buy them directly from the municipality. You can buy them in two places: either on the primary market, which is for newly issued bonds, or on the secondary market, which is a market for trading bonds after they have been issued on the primary market.
How Do You Buy Municipal Bonds on the Primary Market?
If you want to buy a new-issue municipal bond, the process for doing so is called the "retail order period." Getting involved at this level isn't always easy; it's often reserved for those with a high net worth. The retail order period generally lasts a couple of days. It levels the playing field between retail customers and large institutions.
If you buy a bond on the primary market, there are no fees or markups for the purchase. A bank or group of banks will bring the bond issue to the market. You would be required to have an account with one of the banks leading the new issue.
Also, you would receive an offering document. It could also be called a prospectus. The bonds are usually offered on a schedule; this highlights the different maturities and yields. You need to put in a request with the representative you are dealing with. It should include your choice of bond coupon, maturity date, and the number of bonds. Ordinarily, each bond has a value of $1,000.
How Do You Buy Municipal Bonds on the Secondary Market?
The secondary market allows you to buy bonds that have already been issued. You can buy from other investors, bond dealers, banks, and brokerage firms. In order to do so, you would first need to open an account with a firm or bank that deals in bonds.
You could go with an online do-it-yourself firm or a traditional bank or brokerage firm, and depending on which route you choose, you would either work with a representative or fly solo to find bonds that satisfy your specific needs. When buying bonds that way, the price of the bond will usually include a markup. That is the dealer's cost plus profit.
You may be charged an extra commission if you're using a representative or firm to find bonds for you or to execute the transaction. The price of a bond is quoted as if the bond were selling for $100, but the face value is normally $1,000.
If you were quoted a price of $98, and you bought 10 bonds, the total cost would be $98,000 ($98 price of bond x $100 = $9,800 value per bond x 10 bonds = $98,000). Likewise, a bond could be quoted at 102; if you were to buy 10 bonds, the total cost would be $102,000. ($102 price of bond x $100 = $10,200 value per bond x 10 bonds = $102,000.)
What Are Municipal Bond Mutual Funds?
Municipal bond funds offer professional management of a bond portfolio. A manager or group of managers will select and buy bonds for the mutual fund. You would simply buy shares in the municipal bond mutual fund. You can do so through either a traditional or online brokerage firm or directly from a mutual fund company.
One of the advantages of a bond mutual fund is that it offers you smaller amounts of savings and greater diversification than if you had bought individual municipal bonds. One of the disadvantages of a bond mutual fund is the additional level of expense from the fund management fee.
Frequently Asked Questions (FAQs)
How are municipal bonds taxed?
Municipal bonds may be completely tax-exempt, but it depends on your state and local tax law. Qualified municipal bond income and capital gains are always tax-free at the federal level, and many jurisdictions make them tax-free at local levels, as well.
How would reducing income tax rates impact the interest rates of municipal bonds?
Municipal bond rates would likely increase if income tax rates were to fall. One major benefit of municipal bonds is their tax-free status at multiple government levels. If tax rates were to fall, that would decrease the advantage of municipal bonds, and demand for them would likely fall. As demand for bonds falls, issuers must increase rates to attract new investors.