What are High-Yield Municipal Bonds?

Deanira Bong

Local and regional governments issue municipal bonds, or muni bonds, which have certain advantages. Municipal bonds often have preferential tax treatment and people consider them to be safe investments because they are government-issued. It is possible to get higher rates of return compared to the average municipal bond with high-yield municipal bonds, but they carry higher risks. They are often offered by governments with lower credit ratings, which means the risk of default is higher.

The funds derived from high-yield municipal bonds go towards powering public services like street lights.
The funds derived from high-yield municipal bonds go towards powering public services like street lights.

When a government needs funds, one way to going about it is to bonds. The government receives money from selling the bonds and gives back the initial amount of money invested plus interest at the bond maturity date. While federal bonds help pay for federal expenses, the funds raised by municipal bonds go to regional or local governments and their agencies.

Municipal bonds are generally considered to be a very safe investment. High-yield municipal bonds usually carry more risk than the average municipal bonds, and the higher returns serve to encourage investors to take on that risk. Some government agencies issue high-yield bonds because they have lower credit ratings and investors perceive them as being riskier than other government bonds. The risk of investing in high-yield municipal bonds is usually still lower than buying corporate bonds with the same rating, however.

People often buy high-yield municipal bonds because of the tax benefits. In the United States, the gains from high-yield municipal bonds are sometimes exempt from federal, state, and local taxes. This means that municipal bonds can end up providing higher after-tax returns than other investments with the same stated returns. The higher a person's tax bracket, the more benefit he or she derives from the preferential tax treatment that municipal bonds provide. If the high-yield municipals bonds raise funds for projects, such as hospitals and airports, that may benefit private groups, they may not have same tax benefits.

People who want to contribute to their local communities also buy high-yield municipal bonds because these funds go to help support local infrastructure. They derive a sense of satisfaction from seeing their investments go into public facilities that their communities can use. The results of their investments are often tangible, as seen in improved school buildings, new bridges, or improved street lighting.

High-yield municipal bonds can be purchased individually, or an investor can invest in mutual funds or exchange-traded funds (ETFs) that include these bonds. The highest returns are usually obtained from individual bonds, but purchasing them requires expertise and usually involves high transaction costs. Investing in mutual funds does not require sophisticated skills, but involves paying various fees and sometimes has fewer tax advantages. Large investments in ETFs are more economical, but smaller amounts may not produce enough gains to cover the fees.

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