How to Buy Municipal Bonds

Municipal bonds are debt securities that help fund the daily operations or long-term projects of a state, county, city or other government organization. Government entities issue municipal bonds, offering interest payments typically on a semi-annual basis. How to purchase municipal bonds depends on whether they are bought during a new issue or on the secondary market. Investors can acquire them through brokerage firms, banks or directly from the issuing municipality. Mutual funds and ETFs also provide access to diversified pools of municipal bonds.

You can work with a financial advisor to help you determine if this is the right investment for your portfolio.

How to Buy Municipal Bonds

There are several ways to invest in municipal bonds, depending on your financial goals, budget, and preference for professional guidance. Below are the primary methods to consider.

Buying Municipal Bonds Through a Brokerage

One of the most direct ways to purchase municipal bonds is through a brokerage account. Many brokerage firms offer access to both new-issue bonds and those traded on the secondary market. Investors can compare bond prices, credit ratings, yields and tax implications before making a purchase. Some brokers also provide research tools to help evaluate different municipal bonds based on risk and return expectations.

Investing in Municipal Bond ETFs and Mutual Funds

For those looking to invest with a smaller budget or seeking diversification, municipal bond exchange-traded funds (ETFs) and mutual funds offer an alternative. These funds pool multiple municipal bonds, reducing individual bond risk and eliminating the need for in-depth research. They also provide liquidity, allowing investors to buy and sell shares like stocks. Additionally, they can be a cost-effective way to access a diversified municipal bond portfolio without the transaction fees typically associated with individual bond purchases.

Working With a Financial Advisor

Investors who prefer professional guidance may consult a financial advisor to determine whether municipal bonds align with their investment strategy. Many advisors recommend municipal bonds for clients seeking stable, tax-advantaged income, particularly those in higher tax brackets. A financial advisor can help construct a balanced portfolio that integrates municipal bonds with other assets based on risk tolerance and investment horizon.

Using a Robo-Advisor for Municipal Bond Exposure

For an automated approach, robo-advisors offer municipal bond exposure through pre-allocated investment portfolios. These platforms use algorithms to match investors with portfolios based on their risk preferences, often at lower fees than traditional advisors. While robo-advisors may not provide personalized municipal bond selection, they offer a hands-off, cost-effective way to gain diversified exposure to municipal bonds within a broader investment strategy.

Types of Municipal Bonds

Government entities, including state, county, and city governments, issue municipal bonds as debt securities. These funds help finance public infrastructure projects such as roads, highways, schools, and other community developments. In essence, municipal bonds represent a loan from you, the investor, to these governments, with the expectation of regular interest payments. These bonds have fixed maturity dates, often set years in the future.

Tax benefits are a major draw of municipal bonds. For example, the interest income earned over the life of a municipal bond is exempt from federal taxes. In some cases, you may even find that you can skip out on state and local taxes as well. This, however, is ordinarily reserved for residents who invest in their own state or local government’s munis.

1. General Obligation Bonds

General obligation (GO) bonds are backed by the taxing power and credit of the issuing government entity. In layman’s terms, this refers to the method through which investors will be paid back for their investment, which for GO bonds is either through revenue generated from completed projects or taxation. These investments are considered low-risk since they do not require collateral and are backed by the government’s ability to levy taxes.

2. Revenue Bonds

Revenue bonds repay investors using revenue generated from the project they finance. The best way to envision this is the building of a toll plaza on a highway. If a government uses the assets invested in its revenue bonds to fund the tolls, the money that drivers pay will go to repaying investors. They are mostly sold in $5,000 increments, and because they lack taxation as a repayment method, they are riskier than GO bonds. In return, they are paired with stronger interest rates. Revenue bonds are usually long-term investments, as their maturation dates are often a couple decades in the future.

3. Municipal Notes

Unlike GO and revenue bonds, municipal notes mature within a few months to three years. Governments also offer these to fund public projects that require more capital. They come in three forms: tax anticipation notes (TANs), revenue anticipation notes (RANs) and bond anticipation notes (BANs). Each of these choices are secured by taxes, non-tax revenue and future long-term bonds, respectively.

Benefits and Risks of Municipal Bonds

Like most other bonds, municipal bonds are, for the most part, very reliable investments. Backed by county, state or local governments, municipal bonds typically provide reliable semi-annual returns. These investments can help balance a long-term portfolio, as they often take decades to mature.

Despite their low-risk nature, municipal bonds are not immune to risks. The three primary risks to consider are:

Interest Rate Risk: As long as interest rates stay low, the market value of a municipal bond will remain high. However, if interest rates begin to increase, your muni investment could lose overall market value.
Call Risk: Some municipal bonds are callable, which means that government issuers will have the opportunity to pay them off early if interest rates go down. Should this happen, you could lose out on returns.
Credit Risk: Credit ratings indicate the reliability of municipal bonds, helping investors assess their default risk. But even government entities can default, in which case your returns may end up in serious jeopardy.

Comparing Municipal Bonds to Other Investments

Equities are among the riskiest investments, as their value fluctuates based on company performance. This quality, however, affords them much higher return possibilities than their peers, including municipal bonds. The best choice for your portfolio depends on your risk tolerance and long-term financial goals. If retirement is far off, taking on more equities may be a viable option. But if your golden years are on the horizon, municipal bonds offer reliable returns.

ETFs are one of the most popular investment choices. Diversification is key to the health of any portfolio, so the fact that ETFs are inherently diversified makes them a favorite. ETFs come in many versions, such as market-index ETFs, equity ETFs, alternative investment ETFs and even municipal bond ETFs. These funds provide a perfect balance for investors who want the benefits of munis but are unable to diversify due to a lack of trading confidence or funds.

Bottom Line

Municipal bonds can be a valuable investment for investors with varying risk preferences. For risk-averse investors, fixed-income securities like municipal bonds provide stability. Even aggressive investors can benefit from municipal bonds to balance stock holdings. While individual municipal bonds can be costly, municipal bond ETFs provide a more accessible alternative.

Retirement Planning Tips

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