Hi, I'm Scott Albrecht, I'm a Senior Vice President and Senior Portfolio Manager at Federated Investors.
Why should investors consider munis?
Well municipal bonds have been around forever, since the 1840s actually. The first municipal bond was issued to fund the Erie Canal. So they've been used as public infrastructure investments for as long as the country's been in existence. So it's an asset class that's been proven over time. It has high quality relative to other asset classes. In fact, relative to treasuries, it's probably the highest quality asset class available for investors. But the biggest issue is it's tax exempt. After the Tax Reform Act and the creation of 401ks, municipal bonds are the only tax advantaged investment outside of a 401k type of investment. So taxes is probably the number one issue to the munis.
Number two would be diversification. It's a nice diversification tool as far as risk management. To round out the portfolio and it generates that tax exempt income, that most investors what or need. I would also say, from a correlation standpoint, municipal bonds have a lower correlation with other asset classes, especially equities, than other investments. So, it's, from a risk management standpoint, it's a good asset to have as a part of your portfolio. And then another one investors don't think of often is the quality of municipal bonds. The default rates in municipal bonds are much lower than corporates and they provide that unique combination of tax exempt income, high quality, and low correlation with other asset classes.
How can munis help investors achieve their retirement needs?
Well, again, if you're invested outside of your 401k, or company pension plan, the only tax advantaged investment you've got is municipal bonds. So that's a huge advantage. Let's say, for instance, that you live in New York City. New York City tax, and your state tax, and the top federal marginal tax rate, you're paying roughly 49.6% in taxes on your income. So half your income is going into taxes. So municipal bonds are very valuable in that respect. As far as avoiding federal tax, and if you're buying in state bonds, in state taxes. They're triple tax exempt if you're buying an in state municipal bond.
Another big advantage of municipal bonds, especially as you age and you invest in your portfolio, as you get closer to retirement, is income. Municipal bonds are a great provider of income, a safe provider of income as I mentioned. With the quality of municipal bonds versus other things that you should potentially invest in. Especially in this new environment we're in, where investors are reaching for yield, rates are low, it's hard to find income. And municipal bonds, after tax, when they're tax adjusted income, provide a very valuable source of income. Where you get closer to retirement becomes much more important to you. And there's also the price appreciation component to municipal bonds. They're not like CDs or other investments like that, where there really is limited price appreciation. Municipal bonds can move with the market and provide growth that's also necessary, along with the tax exempt income advantages.
So another important thing for investors to think of, as they're investing for retirement and aging, is risk management. As you're investing in your 401k, you're responsible for the risks that you put in your portfolio. So risk management has become ever more important as global and domestic risks have increased. So, using municipal bonds, as part of a risk management strategy in your portfolio, is more important than ever because volatility in the world has increased considerably. And municipal bonds can be used as a good income strategy with less volatility and risk, and, overall, create a better portfolio for you in retirement.
Views are as of 11/8/2019 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Past performance is no guarantee of future results. Diversification does not assure a profit nor protect against loss. Federated Investment Management Company 19-40432 (11/19)