Muni Bonds: Investments you need

If Correspondent

Municipal bonds, sometimes known as "munis," are popular among investors for being low-risk investments and not being subjected to federal taxes. There are disadvantages to buying munis, even though reliable, income-producing bonds should have a place in any well-diversified portfolio. Therefore, before including muni bonds in their investment strategy, those interested in buying them need to consider several things.

A muni is an investment in debt, just like any other bond. The investor lends a chunk to a government/ public organization in exchange for receiving a consistent stream of interest payments

Knowledge about these bonds

A loan to a state, local government, or an organization under their authority is known as a municipal bond. A government or agency may issue these bonds to pay for ongoing costs or to carry out a specific public project. A muni is an investment in debt, just like any other bond. The investor lends a chunk to a government/public organization in exchange for receiving a consistent stream of interest payments.

Reasons behind the investment

Bond purchases enable investors to preserve their cash while generating a consistent income stream (from interest payments). Investors allocate a portion of their total holdings to bonds to counteract the higher risks associated with practically every other sort of investment. The goal of diversity is to achieve this, investments with low risk serve to offset any losses from investments with higher risk. However, even bonds carry some risk. The possibility of an issuer defaulting on its obligations exists.

By looking at the bond's rating, investors can determine the risk level of a bond they are contemplating. Three bond rating companies, Moody's Investors Service, S&P Global, and Fitch Ratings, assign ratings to all bonds sold in the United States. A study of the issuers' creditworthiness is the foundation for bond ratings.

What sets these bonds apart

Municipal bonds' main selling feature is their exemption from federal taxes. Municipal bonds are subject to taxation in some states but not all. Unsurprisingly, it is complicated. Bond interest is irrelevant because seven states do not have any income taxes at all. While some jurisdictions tax out-of-state bonds, other governments do not tax in-state bonds. Before making a decision, consider municipal bonds carefully and weigh them against alternative options for investing your money.

Tax-free municipal bonds are only sometimes wholly tax-free. As said, state income taxes can apply to the interest. In addition, your muni bond interest will be included in calculating your adjusted gross income if you receive Social Security, which could result in a rise in your Social Security income subject to taxation. Less frequently, the deminimus tax and the alternative minimum tax may have tax ramifications.

Tax-free municipal bonds aim to increase your overall rate of return on investment. To reduce your tax liability, be careful not to choose a subpar return on your investment. Like any bonds, municipal bonds are subject to interest rate risk. The risk increases with the bond's term length. You forfeit a better rate if interest rates rise while your bond remains outstanding.

Muni and Corporate Bonds returns

Federal law grants tax-exempt status to bonds that finance local and state projects. Additionally, buyers of bonds from their states or municipalities may not be subject to local or state taxes on the interest. As a result, some municipal matters are triple tax-free. Lower interest yields offset these tax benefits. Ordinarily, the coupon rates on municipal bonds are lower than those on corporate offerings with identical ratings and maturities.

When considering munis, investors should use the tax-equivalent-yield calculation to evaluate the taxable investment-grade and government bonds yields. The yield that a taxable bond needs to have to match or beat a municipal bond's tax-adjusted yield is known as the tax-equivalent yield (TEY). Tax-Free yield equals 1 - (Tax Rate - Tax Equivalent Yield). Municipal bonds are often more advantageous for higher-income investors as they result in more outstanding tax obligations.

Rate of interest risk

Governments that issue muni bonds in the US run a minimal chance of default. However, investors who intend to sell their bonds on the secondary market should be aware that bonds carry interest rate risk by their very nature. Long-term investors may even risk losing their initial investment if interest rates decline. For example, bondholders who sell 30-year issues may not get the total face value of the bond back.

Risk of purchasing power

Annual inflation in the United States over the previous ten years has varied from a low of 0.7% (in 2015) to a high of 7% (in 2021). In all other cases, it was

2.3% or less. As a result, a 20-year municipal bond with a 2.5% yield to an investor in the 25% tax bracket, or a 3.3% tax-equivalent yield, would provide annual returns that would exceed inflation until 2021, at which point it would fall short of doing so. The expected inflation rate in 2023 is 5%, down from 2022's 6.5% rate. A purchasing-power risk is the most significant possible negative to making a long-term bond investment. Ultimately, you'll receive your money back, but it might be worth less than it once did. Strictly sticking to low-yielding municipal bonds is a safe strategy, but it may also mean forgoing gains that outpace inflation and preserve your spending power. A balance between (relatively riskier) stocks and municipal bonds can reduce that risk.

Default danger

In all municipal securities rated by Moody's Investor Service between 1970 and 2018, 0.16% missed investor payments. Due to this, investors consider municipal bonds to be a generally safe choice. The COVID-19 outbreak, which caused commercial activities and taxable receipts to cease along with it, served as the ultimate test of muni bonds' resilience. The total default rate increased year over year to just 0.05% of the $3.9 trillion in outstanding municipal bonds.

Call danger

Investors take on additional risks when buying bonds that include callable options. It indicates that the issuer can cancel the transaction, settle the debt, and halt interest payments. The issuer needs that option to issue a new bond at a lower interest rate if interest rates decrease significantly. Municipal bonds are typically callable. Although their investors will receive their money back, they must find a new place to put it. As a result, they will receive less money from a new bond investment.

Tax traps for municipal bonds

Tax-free municipal bonds are not always wholly tax-free. Senior citizens seeking a reliable source of post-retirement income need to find bonds particularly alluring. That makes Social Security income the most typical trap for buyers of municipal bonds. Although muni bond income is not subject to federal income tax, it is included in the investor's adjusted gross income. Therefore, the amount of the taxpayer's Social Security income subject to tax can increase with an increase in adjusted gross income.

The alternative minimum tax, which explicitly targets taxpayers with significant income from taxsheltered sources, can also apply to high-income persons.

How to invest in tax-free municipal bond funds

An investor can buy and sell bonds through an online brokerage account. A full-service brokerage or a bank is the other option for buying them. A mutual or exchange-traded fund that invests in municipal bonds provides an additional choice. By the end of 2021, municipal bond rates were growing, along with interest rates. A 10-year AAA-rated municipal bonds had a return of 2.15% as of April 16, 2023, down from 2.30% a week earlier. Compared to the previous week, a 20-year AAArated bond returned 3.00% instead of 3.15%. Bonds with a 30-year AAA rating returned 3.20% as opposed to 3.35% the previous week.

Why do investors buy municipal bonds?

• Investors purchase municipal bonds because of the stability of the municipal bond market

• State and local governments have issued bonds for centuries – they are a well-known and well–regulated financial instrument

• Municipal bonds are an extremely safe investment

• The 40-year default rate for corporate bonds is higher than 11%

• Not a single AAA-rated municipal bond defaulted during that time

• The exclusion of interest from federal income tax provides tax savings to investors

Source: munibondsforamerica.org

Municipal bonds may cause losses

If the issuer defaults, you could lose the money you invested in municipal bonds. However, considering that COVID destroyed local tax receipts in 2020, defaults on municipal bonds only represented 0.05% of the $3.9 trillion in outstanding debt at that time; this danger is vanishingly tiny. Additionally, muni bonds could cost you money if you sell them at the wrong moment on the secondary market. Considering the current rates for new issues, the total dollar amount of the outstanding interest payments will decide your price.

Which states and municipal bonds are the best?

Muni bonds rated AAA are the best available from any issuer. One of the major rating agencies has rated the bonds that these state and local governments around the country have issued as AAA. When a government experiences financial difficulties, it's bond ratings decrease (but it will also offer a lower interest rate to entice buyers).

Three of the city of Detroit's general obligation bonds have payments due after its bankruptcy in 2013. That means that year, it was in charge of three of the seven defaults on municipal bonds rated by Moody's Investors. Since then, the city has been able to turn around its "negative" prognosis, which S&P Global revised to a "stable" outlook as of January 2021. Its outstanding debt had a BB+ rating.

One of the most significant municipal bonds is one with a rating of AAA or very near to it. One of the worst kinds of bonds is a local government on the verge of bankruptcy issues. Bond mutual funds or exchange-traded funds (ETFs) are options for investors who want to avoid monitoring the finances of the state and local governments they invest in. It will be run by someone compensated for caring for such things. editor@ifinancemag.com

The bonds are considered as safe as long as the bond issuer isn't financially ruined. The best defence for a bond investor is caution. Defaults are uncommon, although they do occur. An issuer with an AAA, AA, or A rating is in good financial standing. Compare the municipal bond's actual return to other investment options. Of course, saving money on taxes is always wonderful, but not at the expense of earning a higher return elsewhere for a similar risk, like in premium corporate bonds.

For investors looking to generate a steady source of income, particularly throughout their retirement years, municipal or corporate bonds are an excellent solution. Compared to nearly any other option, particularly stocks, highly rated bonds are incredibly safe investments. The tax-free status of municipal bonds is true to its advertising. However, this does not imply that a muni bond's overall return will be your most excellent choice. You must still exercise due diligence to select the finest municipal, corporate, or combination of the two bonds for you. Another option is to invest in a bond ETF or mutual fund and delegate the decision-making to someone else.

If Correspondent

Avariety of forces are buckling down on banks, many of which are accelerating. Long-term factors like demographic aging and climate change are becoming more prominent. Markets have become unstable as a result of shocking occurrences like the COVID-19 outbreak and the crisis in Ukraine. Banks are evolving their business models in response to these forces of change in order to engage clients in highly dynamic digital environments and fulfil new societal expectations. More fundamentally, the industry's quick development and hazy future raise a fundamental question: What is the purpose of banks?

A new SAS-sponsored study by Economist Impact predicts three potential futures for banking, examining the risks and opportunities ahead. Depending on the sequence of events that take place between now and 2035, any of the scenarios are conceivable. The objective of the study is to shed light on how banks might change their purpose and business strategies to benefit consumers, shareholders, communities, and the environment. The study makes it evident that the banks are at a turning point in dealing with issues like climate change, economic dispersion, and chronic economic and social injustices.

Yuxin Lin, Senior Manager of Policy and Insights at Economist Impact said, “The sector’s rapid evolution amidst prevailing uncertainty begs a fundamental question: What is the purpose of banks?”

How banking leaders answer this question – and the business decisions they make as a result – will redefine the entire industry.

Alex Kwiatkowski, Director of Global Financial Services at SAS said, "Banks have the power to elevate not just our global economy but all of humankind. By embracing technology and innovation with intention, banks can pave a more purpose-driven path, where higher purpose and profitability go hand-inhand. And if they don’t embrace this fully, a golden opportunity to make a genuine difference will be squandered, potentially with very serious consequences.”

Scenario one: Can transformed banks regain public trust?

Banks have had issues with their reputations ever since the 2008 financial crisis. According to the 2022 Edelman Trust Barometer, financial services presently inspire confidence in just over half (54%) of the general public, making them one of the least trustworthy industries. Flashing forward to 2035, Scenario one envisions a world where banks wield digital transformation to rehabilitate their image. Banks have backed consumer-focused regulation and improved safeguards against cybercrime and data privacy. More open banking and collaborations that spark profitable new offers are fueled by increased transparency and consumer protections, which boost public confidence. Every aspect of clients' financial lives are seamlessly integrated via digital platforms in personalized, adaptable ways.

Stu Bradley, Senior Vice President of Fraud and Security Intelligence at SAS said, “Consumer trust, built over many years, can be lost in an instant. As digitization accelerates, it is critical that banks create hyper-personalized engagement as they address rising risks. In balancing customer experience and risk, an enterprise decisions approach – where fraud, risk and engagement decisions integrate holistically across the customer journey – can cut costs and streamline banks’ IT infrastructures, while boosting revenue and customer retention.”

Scenario two: Might banks catalyze cross-industry climate action and power the green transition?

It will take unprecedented levels of global cooperation and teamwork to address the climate crisis. The United Nations claims that states' present pledges to cut greenhouse gas emissions are far insufficient to keep global warming to 1.5°C over pre-industrial levels. Action that is swift and firm is necessary to prevent the worst effects of climate change. Scenario two foresees that in 2035, the world community will be committed to addressing climate change, and decolonization will be a top priority for infrastructure, transportation, and energy. Cities have been redesigned to be more resilient to the effects of the climate. Green technologies and affordable renewable energy sources are becoming the norm.

Troy Haines, Senior Vice President and Head of Risk Research and Quantitative Solutions at SAS said, "Climate leadership in the banking sector will drive greater cross-industry progress toward net-zero emissions by 2050 – and it starts now with better analytics, modelling and management of climate risk. In enhancing their ability to model climate risk scenarios and understand potential impacts to their balance sheets and capital, banks can help propel the green transition and advance worldwide climate resilience".

Scenario three: How will banks fare in a geopolitical fragmented world?

Economic and market uncertainty continues even as the world seeks to put the worst of COVID-19 in the rearview mirror. The pandemic's aftermath has exacerbated rivalries among the world's economic superpowers while overtaxing developing nations, whose citizens bear disproportionate burdens. Against this backdrop, it isn’t hard to imagine Scenario three, which depicts a geopolitically contentious world stage in 2035, colored by divergent interests and a retreat of multilateralism among the world’s economic giants. The World Trade Organization has been displaced by bilateral and regional accords. The emergence of digital currencies and rivals’ alternative payment methods has shattered the global financial system.

Theodora Lau, Founder of Unconventional Ventures says, "Deglobalisation, accelerated by recent global events, will likely widen the staggering societal inequalities that plague us today. Indisputably, banking and money are at the heart of it all. Each of us has a role to play in championing a more inclusive and sustainable future with our actions of today".

How fintech challenges banks

The use of personal finance applications has increased recently. The app game is being played by everyone in the banking industry; app providers range from banks that offer their own services to lone developers that make stand-alone saving, budgeting, or money management apps. It is anticipated that the use of personal finance applications will be at its peak in the coming future. These app providers offer current accounts that can only be handled from a phone or tablet, and

Banking in 2035: Climate action paradigm shift

The world is on track to limit global warming to 1.5°C by the end of the century, preventing the most catastrophic effects of climate change

Decarbonisation is taking hold in infrastructure, transport and energy—major urban areas around the world have been redesigned to become energy efficient and climate resilient

Public transport options, including electric buses and subways, are widely accessible, and half the vehicles on the road are now electric or hybrid

Business travel has sharply declined as colleagues are now closely connected across borders, while consumers consciously avoid air travel to reduce their carbon footprint

Consumer and investor pressure pushed businesses to integrate Environmental, social and governance issues into their core strategy

Governments introduced a carbon tax and mandated climate-related disclosures

Strengthened public-private partnerships accelerated breakthroughs in climate technologies staff members give customer support via a live chat service. The option to temporarily block your card from your app in the event of loss or theft is one of the major improvements offered by challenger banks with app-based business models. Instead of phoning customer support for replacements, clients can order a replacement with a few taps on the screen. The services offered by conventional banks might be improved with such straightforward changes. By allowing consumers to just take photos of their checks rather than bringing them into the branch, some traditional banks already assist their clients in this way.

Conventional banks are catching up

There are indications that major banks are adapting to the future of banking by becoming more digitally friendly. For instance, Hello bank! by BNP Paribas Fortis which operates in France, Belgium, and Germany was the first bank to exclusively handle accounts through an app. In keeping with a shifting consumer landscape, Hello Bank! offers assistance and support to its clients via a variety of social media platforms, including an online forum.

Additionally, a lot of these services make international banking simpler than before. The number of apps that assist users in managing their finances on a daily basis has increased in other places. Yolt, for instance, enables users to integrate all of their accounts and monitor them in a single app while also getting advice on their weekly or monthly budget. Standalone savings apps are becoming increasingly common, too. This includes applications that add the difference between the amount a user spends on each transaction and the nearest unit to their savings account. If customers are unable to afford to set aside hundreds of pounds or euros each month, such straightforward developments can give them a new, simple option to save money.

Open banking

Increased awareness of how banks communicate with (and inform) their customers is one of the long-term repercussions of the 2008 financial crisis. The European Union's Payment Services Directive went into effect in 2018. The order upholds restrictions on how users can access their financial data. This is open banking, which gives banks a plethora of new ways to interact with customers and gives consumers a greater understanding of their money. Open banking basically implies that companies that offer online accounts (such as credit and savings cards) must allow their clients to securely exchange data (such as expenditure) with outside companies (such as budgeting applications), if the client so chooses.

Consumer education regarding the advantages of open banking still needs to be done in great detail. Furthermore, banks must appropriately embrace the various ways in which they might exploit these innovations. This suggests that the coming years could be significant for the banking industry's future because several governments are now approving operating more open banking.

editor@ifinancemag.com

It goes without saying that the biggest disadvantage of investing in teenage is the possibility of losing some or all of your money