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Municipal Bonds Offer A Safe Way to Earn Tax Free Income


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Municipal Bonds Have Fallen In Value Due to Default Concerns

Municipal BondsMunicipal Bonds have been out of favor during 2011 because the well regarded financial analyst Meredith Whitney warned in November 2010 about potential defaults in the Municipal Bonds sector, which caused many investors to sell their holdings in Municipal Bonds.  Many Municipal Bonds, and Municipal Bonds investment vehicles such as Municipal Bonds Exchange Traded Funds (ETFs), lost 10% to 20% of their value due to the analyst’s warning, and have yet to fully recover from the price drop.  This price drop has created an excellent buying for opportunity investors interested in investing money in Municipal Bonds.

Many investors rely too heavily of stocks for generating investment returns over long periods of time.  This is largely due to the allure that the stock market has for exceptional profit opportunities and the media coverage of the stock market versus other asset classes.  However, investment advisors almost universally recommend that maintaining a balanced investment portfolio is the best way to protect one’s investments from downturns in various asset classes, such as stocks and real estate.  Typically, a 20% to 30% investment in highly rated bonds is recommended, with even higher bond investment percentages for investors who are near or in
retirement.

Municipal Bonds Offer Tax Free Income

For those looking to shift some of their investment portfolio into bonds or increase their exposure to bonds, now could be the right time to buy Municipal Bonds, as they continue to trade at reduced levels after the late 2010 analyst downgrade.  This is due to ongoing concerns about Municipal Bonds defaults, as the United States economy continues to expand slowly, with indications that a new recession could be brewing due to the European debt crisis.  However, these concerns about Municipal Bonds defaults so far appear to be overblown, as the default rate for Municipal Bonds has not be unusually high in 2011.

What really makes investing in Municipal Bonds appealing is the tax free income that they provide.  Depending on the type of Municipal Bonds and where one lives, an investor may be able to earn tax free interest that is free of local, state, and federal income taxes.  With some Municipal Bonds offering 7% yields, their tax free income is especially appealing in the current low interest rate environment in which many savings accounts earn less than 1% in taxable interest.  Another reason that Municipal Bonds are an appealing investment at this time is that if the Municipal Bonds market recovers from its current slump, investors will not only earn tax free interest on their holdings in Municipal Bonds, but could also make money on the appreciation of the price of the bonds, as they increase in value.  The money made on the appreciation of the price of the bonds would be considered a taxable capital gain when the Municipal Bonds are sold.

Since it is not practical for most individual investors to research the risks associated with investing in specific Municipal Bonds and putting all one’s investment eggs into one bond is not a good investment strategy, it is recommended to invest in Municipal Bonds via an investment vehicle such as an ETF or mutual fund.  There are many ETFs and mutual funds that invest in Municipal Bonds in specific states, thus ensuring that the income earned by investing in Municipal Bonds is tax free in the state in which an investor lives.

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