Bonds are known as investments that come with a lower risk and a lower reward. This simple way of looking at bonds doesn't account for the wide range of bond products on the market. Treasury bonds come with low interest rates and little risk. Some municipal bonds offer higher rates and higher rewards.
To know whether these bonds are good places to put your money, you should learn how they have performed in the past. You should also learn about the risks that come with these sorts of investments.
How Municipal Bonds Performed Over 15 Years
Bloomberg Barclays' Municipal Bond Index is thought to be the best measure for tracking municipal bond returns. The results for the past 25 years are shown in the Bloomberg Barclays Municipal Bond Index table below.
To help you see how they differ, the returns of the Bloomberg Barclays Aggregate Index are also shown next to the muni bond returns to provide a sense of how muni bonds did, compared to the broader fixed-income market. The muni bond market did better than the total bond market in 14 of the 26 years shown.
|Year||Municipal Bonds||Barclays Agg.|
This return data helps show how two factors, interest-rate risk and credit risk, play a role in how muni bonds perform.
Municipal Bond Interest-Rate Risk
With respect to interest-rate risk, you can see that muni bonds do about as well as the broader bond market. In the three years when the Barclays Aggregate Index lost ground (1994, 1999, and 2013), rates rose in two of those years. Municipals finished with a negative return in all three. On the other hand, munis had a positive return in 22 of the 23 years in which the bond market finished the year in a positive or neutral spot.
While muni bonds may go up and down more than many other products that are fixed income, they are still linked to the broader bond market.
Municipal Bond Credit Risk
Credit risk also plays a role in the returns of muni bonds. Credit risk is the risk that a bond will default. It includes broader factors that cause the outlook for defaults to shift. For instance, an economic downturn raises the risk of defaults. This can affect bonds in which credit risk is tied to how they perform. Muni bonds are offered by a wide range of issuers, from states and large cities to small towns and specific entities (such as airports and sewer districts). Because of this, credit risk can also impact how they do.
In 2008, rates fell, and the bond market gained over 5%, but muni bonds lost ground. It reflects a year when a recession started. People who invest their money were steering clear of risks at that time. We saw the housing market collapse, which in turn led to a sharp decline in tax money for cities and other entities. At that point, concerns were raised about the possibility of an increase in the default rate.
Muni bond investors must pay more attention to credit risk than people who invest in Treasury bills.
Municipals also didn't perform well in years when there were big news headlines tied to money: 1994 (the Orange Country, California, bankruptcy), 2010 (Meredith Whitney’s prediction of a “wave of defaults”), and 2013 (Detroit’s bankruptcy and Puerto Rico’s financial troubles). The impact of these events also helps show the fact that there’s more to how well muni bonds do than simply which way interest rates go.
Over the long term, the returns of muni bonds have been fairly close to those of the investment-grade market. Keep in mind that this isn't an apples-to-apples comparison since the interest on muni bonds is tax-free. As a result, the total return of munis after taxes is actually closer to that of investment-grade bonds than it appears at first glance.
The Bottom Line
It's often stated that bonds provide the low-risk returns that conservative investors and those near or in retirement need. But the table above, with its almost 20-point contrast between the best year's returns and the worst, also shows that bonds are by no means risk-free. They are less up-and-down than stocks, but there is still the chance of wild swings. And, as with stocks, it matters a great deal when you begin investing.
Muni bonds have typically been less up-and-down than stocks, but they're still fairly volatile places to invest your money.
Bond returns in the early 1980s were very high, because compounding gave people who put their money in bonds a head start that later investors were not able to match in most cases. Likewise, people who put their money in bonds after the meltdown era that began in 2007 have seen nearly a decade of low returns. Even when the interest rates go up again, it won't make up for this tepid start.