How to Choose a Municipal Bond
When choosing a municipal bond, or muni, there are a lot of things to consider. First, you definitely want munis that are rated. Some municipal offerings are not rated, and these can be risky investments or very illiquid (you may not be able to sell them when you want, if at all).
You should go with the top-rated munis: Moody’s Aaa or Aa. The lower-rated munis may give you a bit of extra yield, but probably are not worth the added risk. Keep in mind that a lower rated bond can be more volatile than a high rated bond. Default isn’t the only risk.
Second, a good number of munis come insured, offering almost absolute safety. You lose a little bit in interest by opting for the insurance guarantee. As long as a muni is rated high and is a general obligation muni (not a revenue muni), consider going without the insurance for the drop of extra juice. General obligation bonds generally don’t default.
Third, you also want to choose a municipal bond that carries a maturity you can live with. If the bond is callable, well, is that something you can live with and be happy with? Callable bonds pay slightly higher coupon rates but are less predictable than noncallable bonds.
Fourth, and perhaps most importantly, because the tax-free status of the muni is undoubtedly a prime motivation for buying a muni in the first place, you want to consider whether you want to buy a national muni or a state muni, and if you buy a state muni, do you want double- or triple-tax-free? Here’s the scoop:
National munis are exempt from federal tax but are not necessarily exempt from state income tax. (Some states tax bond coupon payments and others do not.)
State munis, if purchased by residents of the same state, are typically exempt from state tax, if there is one. Some, but not all, state munis are also exempt from all local taxes.
Munis that are exempt from both federal and state tax are called double-tax-free bonds. Those exempt from federal, state, and local tax are often referred to as triple-tax-free bonds.