Best Municipal Bonds

Did you know that you can invest in the best municipal bonds with Interactive Brokers?

If you think bonds are just for aristocrats or to protect your nest egg, take a closer look. Municipal bonds can pay a great rate – often much higher than treasury bonds – and many are guaranteed by the state, which reduces risk.

Quick Look at the Best Municipal Bonds:

• Nuveen High Yield Municipal Bond Fund 
• Texas Bonds
• Washington Bonds
• New York Bonds
• Florida Bonds
• Georgia Bonds

Best Municipal Bonds

Here's a list of our picks for the best municipal bonds for this year.

Best High-Yield Municipal Bond Fund: Nuveen High Yield Municipal Bond Fund

For the risk takers out there, high-yield municipal bond funds can offer a greater return than other options.

The tradeoff is risk. High-yield funds usually invest at least 50% of their assets in bonds or derivatives that either aren’t rated or are rated BBB – and sometimes lower. With a 7.85% average return for the past year and a 5-star Morningstar rating, the Nuveen High Yield Municipal Bond Fund is a strong performer, especially when you consider its tax-free earnings.

High-yield funds have their risks, resulting in volatility in returns from year to year, but Nuveen’s high yield muni fund is a solid pick to help boost earnings in a diversified portfolio. The fund places its focus on non-investment-grade or unrated municipal bonds and targets opportunities resulting from bond market inefficiencies.

Best States for Bonds

The following states offer excellent opportunities for investing in municipal bonds.

Texas

Texas isn’t just for sunshine and armadillos, it’s also a great place to buy muni bonds. Texas residents don’t pay a state income tax, so there’s no (extra) tax advantage at the state level for Texas bond investors, but the state has a AAA rating and a booming economy to help fill state coffers with sales tax revenue.

Yields for Texas General Obligation (GO) bonds are strong right now, often higher than the AAA-index, providing a prudent bond investment choice with an impressive return. Many municipalities within Texas are also highly rated with attractive yields for low-risk investments.

Bond investors should have no trouble finding muni bonds in Texas with ratings of BBB and higher and with coupon rates as high as 5% or more.

Washington

With its AA+ rating, Washington State is a safe bet for bond buyers. The state has reserves put aside for the proverbial rainy day, of which it has many, helping assure investors that its financial obligations will be met.

We found a number of bonds for the state and for municipalities and projects within Washington that merit a closer look. Coupon rates ranged as high as nearly 10%.

However, investors should invest time in learning more about each bond, particularly if the bond is revenue-based, which makes payments from revenue generated from the project.

New York

The Empire State just might be the perfect place to start building your bond investment empire. New York has a hard-won AA+ rating, proving the state places priority on its credit commitments.

New York is also in a strong position with reserves to help navigate a downturn. Coupon rates ranging up to nearly 13% are available for New York municipal bonds, but higher coupon rates are usually associated with municipalities or projects and may present more risk than bonds for the state itself or for lower-risk municipalities within New York.

Bonds for some projects may also be taxable due to changes in tax law, so careful screening is required for bond investors.

Florida

Similar to Texas, Florida doesn’t have a state income tax, meaning bond investors from the Sunshine State won’t see an extra tax savings for buying Florida muni bonds.

Bonds for Florida state and many of its municipalities and projects aren’t likely to sunburn investors.

Florida is AAA rated, and the state’s economy continues to grow faster than other parts of the nation, with a projected $1 trillion dollar Florida economy projected for 2018. Attractive coupon rates are available for a number of projects and municipalities, with coupon rates of 5% for bonds such as Florida DOT.

Georgia

The Peach State can be a peach for bond investors as well. Georgia’s AAA rating puts the state in the lowest risk category.

Growth in construction is helping fuel Georgia’s economy, but growth is also strong in medical fields and tech fields, leading to the highest employment rates in nearly 20 years.

Muni bonds available for Georgia range from long-term bonds for projects with a high coupon rate to state-issued bonds, which make a secure investment with an attractive yield.

Georgia, as another state with a strong reserve should be in a good position to weather a recession without missing a beat.

What is a Municipal Bond?

Municipal bonds are debt instruments issued by states or municipalities that allow them to borrow money for a specific purpose.

The funds raised by a bond sale might be used to build roads or improve infrastructure, build schools or to support beneficial community projects like hospitals or health centers.

Municipal bond defaults are possible but extremely rare. A bond default occurs when the bond issuer fails to make a payment toward interest or principal within a specified period.

U.S. Treasury bonds are generally regarded to be the safest type of bond investment but generally don’t provide the same rate of return as municipal bonds and don’t have the same tax advantages found with municipal bonds. 

Check out our guide on how to buy municipal bonds.

Municipal Bond Advantages

Investing in municipal bonds bring several advantages. It even has some advantages over other types of bonds. Let's take a look at the advantages of municipal bonds.

Attractive Yields

If you follow U.S. Treasury market yields, you know that yields don’t change much on a day-to-day basis and are generally on par with the dividend yield of the S&P 500.

• U.S. Treasuries range from under 2% up to just under 3%. A higher yield is only available for 30-year notes. Municipal bonds generally offer a more attractive yield.
• The highest-rated bonds, AA or AAA, can be higher than the 30-year treasury note, but with a shorter time to maturity.
• Municipal bond yields are typically higher when the bond rating is lower or the duration is longer.
• A lower bond rating can represent a potential for risk and longer-term bonds can have opportunity costs because interest rates can change over time, possibly making the bond less attractive as an investment.

Step down one rating to BBB rated bonds (which are still considered to be investment grade bonds). You’ll find higher yields with a slightly higher chance of default, typically around 1% after 10 years.

Dropping below a BBB rating for bonds can be a risky proposition, as you end up with default rates high enough to threaten the bond yield

It’s important to note that a bond’s yield is really a yield to maturity. When bonds are resold, the selling market often prices in changes in interest rates and other factors, causing a divergence between the yield and the coupon rate.

Tax-Free Returns

Sometimes the IRS can be friendly to investors, particularly in the case of municipal bonds, which are exempt from federal income tax. If you buy bonds issued in your home state, you can expect the interest you earn to be exempt from state taxes as well.

If you’re in a higher tax bracket or if you plan to be at some point, municipal bonds can be a great addition to your portfolio because the yield isn’t taxable, making it equivalent to a higher yield in taxable investments, such as the yields of corporate bonds, treasury notes, interest from CDs or stock dividends.

Secured by Tax Authority

Many municipal bonds are structured general-obligation bonds, which means they’re supported by the full taxing authority of the issuer.

States or municipalities can raise taxes as needed to meet their financial obligations including bond payments. Revenue bonds are another type of municipal bond – but rather than being paid through general revenues generated by states or municipalities, revenue bonds are paid off through the revenue from specific projects for which the bonds are issued, such as a toll bridge.

Municipal Bond Disadvantages

Municipal bonds also bring some disadvantages. Here are a few that stand out.

Volatility

Prices for bonds can be just as volatile as prices for equities due to changes in risk or changes in interest rates. A bond purchased during a low interest rate environment may see its value adversely affected if interest rates go up because better earning opportunities are available in a higher interest environment. Meaning that interest payments could change without warning.

If your goal for investing in municipal bonds is a buy-and-hold strategy, volatility shouldn’t be a concern because you’ll be holding the bond until maturity. Once it’s mature, you’ll be paid the full principal of the savings bond. Bond prices are fixed when you purchase them, but the interest payments can shift.

Possible Bankruptcy

Municipalities don’t often go out of business, but they can find themselves in financially challenging situations that can prevent the state or municipality from making required payments on the interest or principal for issued government bonds.

In 2014, a federal judge approved a bankruptcy plan for Detroit which left some bondholders holding bonds of questionable worth. In 2016, Puerto Rico defaulted on $58 million in debt, and since the recent hurricane impacted Puerto Rico, the future of its bond payments remains uncertain.

Limited Redemption Options

Remember, too, that you can only redeem these bonds electronically through TreasuryDirect. While this is not a disadvantage, there’s not as much flexibility as you might imagine. However, your investor advisor or issuer can often redeem for you.

What to Look for in Municipal Bonds

These are theactors to consider when choosing municipal bonds.

BBB Rating or Higher

Default rates for bonds rated BBB are slightly over 1%, with bonds rated A, AA or AAA, boasting a default rate well below 1%.

Higher risk bonds, even as part of a diversified portfolio, can destroy the overall bond portfolio yield if any of the bonds default. Moody and S&P use a slightly different convention for the rating, but both lead the rating name with letters A, B, C, etc. 

Taxable Equivalent Yield

Compare yields for municipal bonds to their taxable equivalents for bonds with similar ratings. In many cases, you’ll find that the taxable equivalent yield of municipal bonds will make munis a more attractive choice.

General Obligation Bonds

They are effectively secured by the taxing authority of the issuer. This means that the state or municipality can raise taxes to meet its financial obligations, including bond payments.

What to Carefully Watch

There are certain signals that you should consider before deciding whether municipal bonds are worth investing in.

Bonds Rated Lower Than BBB

The default rate for municipal bonds begins to skyrocket for bonds rated BB or lower, with bonds rated C or lower sometimes having staggeringly high default rates.

Yields Too Good (or bad) to be True

If the yield from a municipal bond seems too good to be true, check the bond rating from Moody or S&P. High yields and lower bond ratings can go hand-in-hand.

Also, check the coupon amount. Bonds that are traded after issuance can have posted yields that don’t make quite as much sense as the coupon rate. A higher yield can be a more profitable bond investment – but only if the state or municipality doesn’t default on its debt obligations.

Revenue Bonds

These pay bondholders from revenue generated from the project for which the bond was issued. This isn’t necessarily a bad thing, but it can create additional risk.

State and local governments might be good at governing (or not) but that’s not a guarantee that any revenue-based ventures will be successful, potentially creating a risk that bond obligations won’t be paid.

Best Brokers for Municipal Bonds

Online brokers make it easy to invest in municipal bonds. Take a look at our top picks for the best online brokerages.

Best For

• Most Available Bonds

get startedSecurely through Interactive Brokers’ website

Interactive Brokers

IBKR has no mark-ups or built in spreads and low and fully transparent commissions on bonds

• Treasury bills, notes and bonds: 0.2 bps for the first USD 1 million
  of face value, plus 0.01 bps for face value above USD 1 million
• Corporate bonds: 10 bps for the first USD 10,000 of face value,
  plus 2.5 bps for face value above USD 10,000
• Municipal bonds: 5 bps for the first USD 10,000 of face value,
  plus 1.25 bps for face value above USD 10,000

Alternatives to Bond Funds

As a municipal bond investor, there are several ways in which you can invest in the debt security market. Yes, a fixed income security may sound enticing, but what if you’re not convinced? You can use these investment options:

• Purchase bonds individually,
• Invest through a bond fund managed by a mutual fund company,
• Purchase municipal bond ETFs or
• Invest in unit investment trusts.

Municipal Bond ETFs

Exchange traded funds (ETFs) are similar to mutual funds but are openly traded on an exchange. There’s no need to establish an account with a mutual fund company because ETFs trade just like stocks and are accessible from any trading account.

Like bond mutual funds, bond ETFs can be passively managed, tracking a bond index, or can be actively managed by a fund manager or team.

Take a look at Benzinga's picks for the best bond ETFs.

Unit Investment Trusts

A unit investment trust is structured similarly to a mutual fund. The trust is an investment firm or company that bundles similar assets into units, which are then sold to investors. This may sound a lot like shares of mutual funds – and it is.

Unit investment trusts can be used with stocks or with bonds, or even bond derivatives, and can specialize in certain types of bonds, such as municipal bonds. With a unit investment trust structure, you don’t own the bonds directly. The trust owns the bonds and you own units within the trust. The largest distinction between unit investment trusts and mutual funds is that the bonds held by a unit investment trust are held until maturity.

Bond funds managed by mutual fund companies typically trade in and out of bond investments according to the stated objectives of the bond fund. Unit investment trusts are best for the buy-and-hold investor because maturity dates can range up to 30 years from purchase date.

Best Municipal Bonds Methodology

Here’s the bad news – but it’s not all bad. The best municipal bonds are usually sold quickly to brokers, funds, banks or institutional investors. This leaves the retail investor grasping at empty space where the bonds once were or digging around for odd lots.

Nevertheless, we used the following information to choose the best of the best:

• Ratings
• Risk
• Yields

We also took reserves into consideration, which can provide insight into how well a state can navigate the next recession. States with some extra money in the bank may be more likely to meet their debt obligations without missing a beat.

Invest in Municipal Bonds Now

Not every bond is a great buy. Many of the bonds with the highest yields offer such high returns because the risk is greater. From issue price to interest payments, you can turn to paper savings bonds, a range of municipal securities and much more.

Consider bonds as a part of a well-diversified portfolio. Start with Benzinga’s recommendations to find the best bonds and online broker today. You can also research the market values of these assets, the Treasury yield curve and much more.

Want to learn more about investing? Check out Benzinga's guides to the best online brokerages, how to trade stocks for free and how to buy corporate bonds.

Frequently Asked Questions