All about investment

by A. Bohart

Tax free municipal bonds are an alternative investment for those looking to diversify their investment holdings in a tax-free manner, but they may not be right for everyone. There are several things to consider when making the decision on whether or not to invest in these. Let's take a look at some of those considerations.

First, let's take a look at just what a tax-free municipal bond, or MUNI for short, is. A MUNI is a bond issued by a city, state, or county government to finance some new taxpayer-financed project. These projects could include things like highway improvements, new schools, and new libraries. The income received from these bonds are always free from Federal income tax, and may be free from state income tax as well, provided the investor resides in the same state as the source of the bonds.

How do you know if MUNI's are right for you? The short answer is, the higher your income tax bracket, the more benefit you will receive from a tax-free bond. If you were to compare a taxable bond with a tax-free MUNI, then you would divide the tax free yield of the bond by 1 - your income tax bracket. For instance, if your MUNI is a 5% yield bond and your income tax bracket were 15%, then you would divide 5 by .85 to get an equivalent yield of 5.88%. So, an equivalent taxable bond would need to yield 5.88% to enjoy the same income benefit as the tax-free bond.

Another motivation for investing in tax free municipal bonds lies completely outside of the financial arena, and that is the desire to help support local projects. By investing in your city's projects, you can support your local economy and overall community. The income derived from the bonds can be the icing on the cake in this particular instance!

A final thing to consider when deciding on whether or not to invest in any particular tax-free MUNI is the financial solvency of the issuing entity. In general terms, financial analysts recommend that the issuing party should have the following minimum characteristics:

1. The population of the entity should be at least 10,000
2. The entity should have a diverse economy with many sources of income - No one company towns here.
3. The entity should have a long history of prompt interest payments on it's bonds.

Any bonds that fall short of these minimum criteria should, for the most part, be considered far too risky for the average investor's portfolio.

As with any investment, careful consideration and research should be done before making the final decision to invest. Tax-free municipal bonds can be a great way to earn some non-taxable income, provided you do your homework. So, are tax-free MUNI's right for you?