Three Main Uses Tax Exempt Savings Provides Income Protect Principal

What is it?
Municipal bonds, sometimes referred to as "munis", are debt securities issued by a state, municipality or county, to finance its capital expenditures. Such expenditures might include the construction of highways, bridges or schools. Munis are bought for their favorable tax implications and are popular with people in high income tax brackets.

The major advantage to municipal bonds is many of them are exempt from federal taxes and most from state and local taxes, especially if you live in the state that issues the municipal bond. F or example, Washington residents can get triple tax savings by buying WA municipal bonds because they pay no federal, state or local income tax on them. For this reason munis are extremely popular with wealthy individuals because they avoid having to claim the income as tax.

There are two types of municipal debt:
Public Purpose - these are bonds used for government projects and are always tax-exempt.

Private Purpose - slightly different in the sense that they are only tax exempt if it clearly says so, otherwise you are subject to the provisions placed on the bond. (This can vary widely from bond to bond). These types of munis are called private purpose because they usually fund a project that will benefit both government and a private entity.

Objectives and Risks:
For the most part investors should buy munis for income. While capital appreciation is possible in a falling interest rate environment this isn't considered to be a primary objective. One thing to remember when looking at muni quotes is their yield is usually quite low because the tax benefits are usually priced into the bond already.

There aren't any substantial risks associated with buying a muni, just make sure to research the municipality you are purchasing it from. For example a New York muni is probably a little more credit worthy than one from Puddle Jump, Wyoming.

How to Buy or Sell it:
Municipal Bonds can be purchased at almost any full service broker and most discount brokers. Some municipalities also allow you to purchase the bonds directly through them. Minimum investment in a muni can start in the thousands of dollars.

A new and popular way to invest in munis is through municipal bond funds, which pool together munis from various states and cities, to give you a well diversified portfolio while getting all the benefits that you would get purchasing the muni yourself.

Strengths:

income from municipal bonds are tax exempt, but capital gains are not. considered to be a very low risk investment.

Weaknesses:

municipal bonds in smaller municipalities can sometimes be difficult to sell quickly.

Next: 13. Mutual Funds