How rising interest rates may affect muni bond investors

How rising interest rates may affect muni bond investors

Cash has piled into municipal bonds, generally known as muni bonds or “munis,” as traders intention to decrease danger and cut back taxes. However some could fear about worth drops amid rising rates of interest.

Buyers funneled a record-breaking $96.8 billion of web cash into U.S. muni mutual and exchange-traded funds in 2021, in keeping with Refinitiv Lipper information.  

“2021 was fairly important,” mentioned Tom Kozlik, head of municipal analysis and analytics at Hilltop Securities. “We noticed extra fiscal coverage targeted on public finance than we ever have in a single yr.”

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Some traders, nevertheless, could now be bracing for the Federal Reserve’s deliberate rate of interest hikes, which can trigger worth declines.

However advisors are nonetheless optimistic about muni bonds for sure purchasers, significantly for long-term portfolios.

“Greater rates of interest will bode nicely for the common municipal bond investor,” mentioned licensed monetary planner Jay Spector, accomplice at Barton Spector Wealth Methods in Scottsdale, Arizona. “They’re probably going to see increased coupon charges.”

And when you’re keen to purchase muni bonds with increased yields, you’ll have the prospect to purchase property at a cheaper price, he mentioned.

“I completely suppose that munis have a spot in somebody’s taxable portfolio,” mentioned Spector.

Tax advantages

The tax advantages of muni bonds proceed to shine, because the property typically take pleasure in no federal tax on curiosity, and keep away from state and native levies on yields, relying on the place traders dwell.

Whereas lots of President Joe Biden’s proposed tax hikes have faltered in Congress, levies will increase after 2025 as provisions sunset from Republicans’ 2017 tax overhaul.

“Munis gives you that counterbalance to potential inflationary hikes in tax rates,” said Ian Weinberg, CFP and CEO of Family Wealth and Pension Management in Woodbury, New York.

You could walk into a disaster if you do it yourself.

Ian Weinberg

CEO of Family Wealth and Pension Management

Although muni bonds may offer lower interest than a corporate bond with similar credit risk, the pre-tax yields may be deceiving.

For example, let’s say you’re in the 35% tax bracket, comparing an 8% corporate bond to a 5.25% muni bond. While 8% may seem like a higher return, the corporate bond pays 5.2% after taxes.

How to craft a muni bond strategy

Crafting a muni bond portfolio isn’t easy, even for advisors, who may rely on institutional muni bond managers to adjust holdings based on interest rates, credit quality changes and more.

“You could walk into a disaster if you do it yourself,” Weinberg said, explaining the high level of monitoring needed for muni bond investing.

For example, muni bond issuers may “call” the asset, paying it off before maturity, when interest rates drop. The move allows issuers to replace it with another lower-paying bond, blocking investors from the higher rate.

Muni bond managers may add call protection to stop issuers from calling the assets for a set period, making adjustments to the portfolio over time.

While credit concerns in the public finance market have “really decreased,” according to Kozlik, it’s also critical to research each muni bond’s credit quality, which may change over time due to local economic factors.

“It’s not as easy as just throwing a dart against the board and picking a stock,” Spector added.

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