Follow these 10 tips to avoid some of the most common pitfalls of municipal bond investing.
1. Consider your investment objectives and the level of risk you're willing to accept. Understand that bonds with higher yields and longer maturities generally come with higher risk.
2. Determine when you want your money (principal) back. Municipal securities can be difficult to sell before maturity.
3. Decide the type of muni bond you are interested in purchasing. There are general obligation bonds, revenue bonds and conduit bonds, for instance. Make sure you understand the terms, features and risk factors, as well as where the funds to repay the debt will come from.
4. Review the primary document describing the bond—called an Official Statement—and supplements and other continuing disclosures made by the issuer. You can find them on the Municipal Securities Rulemaking Board's EMMA website. Discuss the information with your investment professional.
5. Confirm whether the issuer is current in its continuing disclosure filings. Be wary of bonds whose issuers are not: it may be difficult to determine that issuer's current financial condition.
6. Review the bond's credit rating and the issuer's creditworthiness to get an idea of the risk that the issuer will default. If the issuer's rating was recently downgraded, think carefully about the investment.
7. Check the credit rating of any insurer or third party backing the bond. The additional insurance is only as good as the entity providing it.
8. Find out whether the market price of the bond is above or below its par value if you're buying in the secondary market. There could be many reasons for either situation, such as changes in the creditworthiness of a bond's issuer or in prevailing interest rates. You just need to understand why the price is what it is.
9. Ask how frequently you'll receive interest payments. Most municipal bonds pay interest semiannually. Zero coupon municipal bonds, however, pay all interest along with the principal when the bond matures. Variable rate bonds typically pay interest more frequently, often on a monthly basis, and in differing amounts.
10. Find out if the issuer can call or redeem the bond before maturity. You can find this information on EMMA. This is another feature that you'll want to consider when deciding whether to buy a particular bond.
You should receive a confirmation statement after buying a bond. Review it as soon as you receive it to ensure the information is accurate and in line with what your investment professional told you.
Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA).
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