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, and how you can add them to your investment portfolio. One way is to purchase individual municipal bonds, and the second is to buy a mutual fund that invests in municipal bonds.
How to Buy Individual Municipal Bonds
You can buy individual municipal bonds through bond dealers, banks, brokerage firms, and in a few cases, directly from the municipality. You can buy them either on the primary market, which is for new-issue bonds, or on the secondary market, which is a market for trading bonds after the bond has already been issued on the primary market.
Buying Municipal Bonds on the Primary Market
If an investor wants to buy a new-issue municipal bond, the process for doing so is called the retail order period. Understand that getting involved at this level can be difficult and is often reserved for high-net-worth individuals. The retail order period typically lasts a couple of days and levels the playing field between retail customers and large institutions.
If you purchase a bond in 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 and you would be required to have an account with one of the banks leading the new issue or syndicating the offering.
Additionally, you would be delivered an offering document or prospectus. The bonds are typically offered on a schedule, which highlights the different maturities and yields. You need to put in a request with the investment representative you are dealing with for your choice of bond coupon, maturity date, and the number of bonds. Ordinarily, each bond has a value of $1,000.
Buying Municipal Bonds on the Secondary Market
The secondary market allows investors to buy bonds, which have already been issued, from other investors, bond dealers, banks and brokerage firms. In order to purchase bonds, 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 purchasing bonds on the secondary market, the price of the bond will usually include a markup, which is the dealer's cost, plus profit.
You may be charged an additional 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 was selling for $100. However, the face value is normally $1,000.
So, 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 and if you bought 10 bonds, the total cost would be $102,000 ($102 price of bond x $100 = $10,020 value per bond x 10 bonds = $102, 000).
Municipal Bond Mutual Funds
Municipal bond funds offer professional management of a bond portfolio. When investing in a municipal bond fund, a manager or group of managers select and buy bonds for the mutual fund. As an investor, you would simply buy shares in the municipal bond mutual fund 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 they offer investors with smaller amounts of savings and greater diversification than they otherwise would have achieved when purchasing individual municipal bonds. One of the disadvantages of a bond mutual fund is the additional level of expense from the fund management fee.