But tax-free municipal bonds have jumped in value, emerging as one of the few winners in the post-election landscape.
Expectations are, of course, for taxes to rise in 2013. That makes most muni bonds, which are exempt from federal taxes, more attractive for taxpayers in higher brackets.
In addition, municipal bond income is not subject to the 3.8% surtax on investment income that will kick in for wealthier taxpayers in 2013.
That could move munis to the top of the “favorite investment list” next year.
“Municipal bonds have benefited from the fact that they offer higher yields than Treasuries, but still entail relatively low risk of default,” explain analysts at Putnam investments.
Plus, municipal bonds offer diversification advantages when added to your portfolio, since muni bonds don’t move in sync with other bonds.
Still, it’s not all smooth sailing for munis. There are a few things investors need to look out for in 2013.
- Rumors are that Congress might try to limit the tax benefits of municipal bonds for the highest income taxpayers. If that happens, the tax advantages of munis will still be intact but slightly reduced.
- Investors need to keep an eye on muni credit quality, and select bonds with care. In 2007, 70% of all muni bonds were rated “AAA” due to municipal bond insurance. Now, only 13% of bonds have the top rating as bond insurance has virtually disappeared. Investors looking for rigorous credit analysis, diversification and liquidity are far better off today using a municipal bond fund or ETF.
- Since muni prices have already moved upward, the sector is a little less attractive for those who have yet to buy in. And many existing bonds are getting called, leaving investors struggling with the task of finding good replacement investments.
The Takeaway: Municipal bonds remain attractive investments for tax-sensitive investors looking for relative stability and quality in an uncertain world.