Tag Archives: bonds

Market Analysis

Take Advantage of Tax-Free Municipal Bonds

When you purchase a municipal bond, you’re loaning money to a municipality, city, village, county, or state. Typically, the municipality borrows money to pay for infrastructure projects such as building or repairing roads or a community center. The municipality generally pays back the bonds with money made from those projects – by paying off a bridge bond with money that is raised from bridge tolls, for instance.

Most municipal bonds are exempt from federal taxes on the interest they earn. Additionally, if the bond is issued in the state that you live in, you may owe no state taxes either. However, interest on some municipal bonds, often called private activity bonds, can still fall into alternative minimum tax guidelines and to state and local taxes. Also, buying and selling municipal bonds can be subject to capital gains taxes.

Nevertheless, tax-free investments can make your portfolio more tax efficient, especially if you fall into a high tax bracket and if the current tax policies are changing for the worse. Municipal bonds can help you diversify your fixed income positions as well. Additionally, municipal bonds are generally considered low-risk adding steady income to your portfolio, thereby can be very attractive to risk-averse investors.

Tax-free vs. taxable bonds
Municipal bonds, because they are generally more conservative and because the income is protected from federal income taxes typically pay lower interest rates than comparable taxable bonds. If you fall into a higher tax bracket, then tax-free investments become more valuable to you.

To decide whether a tax-free bond is better than a taxable bond, convert the tax free yield into its taxable equivalent yield. The formula to accomplish this is simply: Tax-equivalent yield = Tax-free yield / (1- your federal tax bracket).

For example, let’s say you want to get into a tax-free bond that pays 2%, and you’re in the 28% federal income tax bracket. Further, assume you live in the state that issues the loan so there aren’t any state or local taxes that apply to the municipal bond. For someone in your situation, the tax-free bond’s equivalent taxable yield is 2 / (1 – 0.28). Your bond’s tax-equivalent yield is 2.78%. That’s potentially a good purchase if comparable taxable bonds are paying 2.5% but the arrangement might not be as lucrative if comparable taxable bonds are yielding 2.8%.

Let’s look at another example. Say you and your spouse file jointly and report a net taxable income of $245,000 which makes you fall in the 33% federal income tax bracket in 2010. Assume that state and local taxes don’t apply. Below is a small table that shows tax-free bond yields and their taxable equivalents.

In this situation the investor may consider purchasing a tax-free bond yielding 2.5% or a comparable taxable bond yielding 4%. In this scenario it would be wiser to buy the taxable bond, because the taxable bond’s yield is greater than the tax-free bond’s tax-equivalent yield of 3.73%. The table below shows possible tax-free bond yields and their taxable equivalents.

Municipal bond mutual funds
Municipal bond mutual funds offer greater portfolio diversification for investors that are not looking to dabble in individual bond purchases or want to buy into multiple municipal bonds.

The formula is the same as it is for a single bond. Say a taxable bond fund offers a yield of 3% while a tax free fund offers 2.5%. An individual that falls into the 28% tax bracket would find, using the previous formula, that the tax-free bond’s tax-equivalent yield of 3.47% is more than the taxable bond’s yield, making it a better decision to buy into the tax-free fund.

A Financial Advisor can provide you with more information on municipal bonds and guide you on how to incorporate them into your overall portfolio that suits your investment goals.

General Investing

Types Of Investment Bonds

There are many types of investment bonds in the market. Each type of investment bond has its own feature, which make them unique. It is very important to know the type of investment bond featured benefits. If an investment bond feature benefits the investor, then the investment has lower risk, so as the yield, and its price should be higher.

In the other way round, If an investment bond feature benefits the issuer, then the investment has higher risk and yield, and its price should be lower. Therefore, as an investor, once we know who benefits from the feature, then we stand a better investment position whether to pay more or less for the type of investment bond before investing. Below are some of the most common bonds in the market.

Government bonds – are issued by the monetary authority of a country. At the time of issue, government bonds have maturity period from as short as one year to as long as 20 years.

Corporate bonds – are issued by corporations, mainly bought and sold by private and public institutions. They offer limited interest from retail investors.

Secured bonds – are backed by some specified assets such as mortgages or account receivables for investors to be convinced to park with their money. For example, a mortgage backed secured bond bundles mortgage, and then sells investors the right to receive the payments that consumers make on those mortgage loans.

Unsecured bonds – or sometimes called debentures are the most commonly issued type of investment bond. Although it may sound risky, they are generally not. They are backed by the issuer’s credit quality. In general, the higher the issuer’s credit quality, the higher the chance the borrower will make the payment to investors as promised. Therefore, the investor’s risk is reduced. Debentures are issued by high credit quality corporations and institutions, and they are often more highly rated than secured, asset backed investment bonds.

Convertible bonds – are hybrid investment which contains a bond and a stock. If an interest rate risen, the bond will fall in value. However, investor can still benefit from the risen stock price by converting it to common stock. If an investor choose not to exercise the convertible, the investor can benefit from the bond’s interest income until the its maturity. These types of investment bond is suitable for investors with low risk profile, and seek for regular income with downside protection against falling share prices. Convertible bonds rate of return is lower than non-convertible bonds.

High yield bonds – as the name suggested, pay higher interest rates to investors. This types of investment bonds’ grade is lower, and are issued by emerging market economies such as those good companies which fallen on bad economy times. Therefore, they are riskier than investment graded bonds.

Zero-coupon bonds – pay no coupon interest during the tenure of the bond. But, the coupon interest is accumulated and paid in one lump sum at the time of maturity. This types of investment bonds are normally sold at a discount.

Floating-rate bonds – or name floaters, is a type of investment bond which periodically adjust the coupon interest rates base on the current market interest rates. If the market interest rates risen, the coupon interest rate will be adjusted to higher. If the market interest rates fallen, the coupon interest rate will be adjusted to lower.

Callable bonds – is riskier and offer a higher rate of return. The issuers have the right to call back the bond anytime and repay its debt before maturity. This occasion normally happens when interest rates fall, the issuers will call back the bond and reissue another bond at a lower rate of interest.

General Investing

Fixed Rate Bonds ‘Effective Tool To Beat Inflation’

Fixed rate bonds continue to dominate the higher end of the savings market.

Although these savings accounts offer guaranteed returns, there is a small gamble involved when using fixed rate bonds, as the general census follow the Bank of England base rate so there is no guarantee that you will continue to benefit from the best rates throughout the full term.

On the other hand, the base rate can also remain low or fall significantly as we saw when the recession emerged. In this case if you were lucky enough to put your savings into a fixed rate bond you could still be earning well above the average.

Some might think that because the base rate is at its lowest level on record, it can only go one way – up. But on closer inspection you will see that it hasn’t moved in over 18 months, and with the inflation rate exceeding 3% for the fifth month now, unless you find an alternative savings engine your savings account rate is unlikely to be strong enough to avoid the effects of erosion.

A basic rate tax payer currently needs to be earning at least 3.88% from their account to stop inflation eroding their savings, while a higher rate tax payer must earn 5.17% – a rate that’s unheard of in today’s market.

Savers hit hardest by the rise in inflation are those that rely on the in interest earned from their savings as a source of income, many of whom are pensioners. The average savings pot held by a basic rate tax payer is in effectively being eroded at an annual rate of 2.51%.

Darren Cook, spokesperson for Moneyfacts.co.uk, said: “Inflation is a stealthy enemy for savers and when rates are low, it quietly erodes the spending power of a hard earned nest egg. Savers may have had a short respite from a marginal fall in inflation, but savings rates have hit a plateau and may be there for a while.

“The average one year fixed bond rate has fallen from 3.07% in January to only 2.54% today and the average five year fixed bond rate has fallen from 4.56% to 4.08% for the same period.

“The average instant access savings rate is still at rock bottom at a rate of only 0.74%. The only trigger for any improvement in savings rates may be a surprise increase in the Base rate by the Bank of England, but this is most likely not to happen soon.

“To just break even, higher rate tax payers need to find an account paying 5.17%, a level that is nigh on impossible to achieve.

“Only 87 out of a possible 1,244 accounts allow a basic rate tax payer to just break even at 3.88%. 51 ISA accounts beat inflation at 3.10%.

“It is difficult for savers to try and beat inflation but at best, they should try and stay within an arms length and try and weather the storm of low rates and high inflation.”

Some economists believe that the base rate will remain at it’s historic low of 0.5% until 2014. If this were the case, then by investing in a 4-5 year fixed rate bond could allow you to earn at rate of 4.75% – around 2% higher than some of the best savings accounts on the current market. ICICI fixed rate bonds offer a range of terms and sit at the top of many comparison tables.

If you’re willing to lock your funds away for a period of 5 years, you could earn 4.75%, with the ICICI fixed rate bond.