There is an investment that is often exempt from federal income tax and state income tax, making it a useful tool for investors concerned about their tax burdens. Even better, this investment has minimal risk, making it a worthwhile option these days. The investment is the municipal bond — a bond issued by local governments and their agencies. Cities, counties, school districts, publicly owned airports, redevelopment agencies and other local government agencies can all sell municipal bonds.

Because of the wide variety of bond issuers, the terms of a municipal bond can vary. Repayment schedules, interest and even taxability can all vary between bonds, so it’s very important to research any bond you’re considering buying — perhaps more so than some other kinds of investments. Among other things you might want to consider before purchasing is the bond rating, which is assigned by one of the three main rating agencies in the U.S.: Standard & Poor’s, Moody’s and Fitch. The bond rating addresses the liklihood that the bond will be repaid — that is, whether you’ll make money.

The security of a municipal bond can vary based on how the bond is secured. A bond is secured by its repayment source — where the money will come from to repay the bond. There are a wide variety of repayment sources, but three show up particularly often:

• General obligation bonds: These are the bonds with the most security (and lowest payouts) because the issuer promises to repay based on its full faith and credit.
• Revenue bonds: These bonds must be repaid from a specific stream of income (such utility fees). If money is not available from that income stream, bonds may not be repaid.
• Assessment bongs: These bonds are repaid based on property tax assessments within the issuer’s boundaries. Because tax assessments can vary, repayment is less secure.

The drawback to municipal bonds is that they generate lower amounts of interest than other investments — or even other bonds. Because corporate bonds are riskier, they pay a higher rate of interest to investors. Some municipal bonds are considered comparable to corporate bonds because, when you consider the tax advantages, an investor can walk away with the same amount from a municipal bonds as from a corporate bond with a higher interest rate. Despite this fact, many investors consider municipal bonds a less than ideal investment, because few bonds really offer an interest rate that compares with many corporate bonds. Municipal bonds have a level of security, however, that can make them a better choice for investment during times when other investments seem a little too risky.

For more information about municipal securities, I would suggest MSRB’s Electronic Municipal Market Access, which has an excellent set of educational materials. The site also has up to date information about recent trades as well as a tool to search for municipal bonds. It’s certainly worth doing research before you make a decision regarding municipal bonds — you may want to consult with a financial advisor as well, due to the fact that is impossible to offer investment advice that will work for everyone.

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