Investors are fully justified in asking if investing in today’s muni bond market is safe. The answer they receive is likely to vary based on to whom the question is posed. If they ask a politician, the likely answer will be yes. If they ask a ratings agency, that answer may change to maybe. The fact is, a rating of AAA is stronger than a rating of B. And bond analysts will say all day long that the ratio of defaults is still low.
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But that’s reflective of the past. Does it say anything meaningful about the future?
The tax-free aspect of municipal bond investing is probably as attractive as it has ever been with tax spikes looming and investors scrambling to prepare for the worst if Congress does not act to extend current tax laws.
But what good is tax free income if loss of principal becomes high? Overspending and fiscal irresponsibility has not been limited to the federal government. The economic woes of the nation have made it more difficult for states to meet their fiscal responsibilities and more and more of them are simply abdicating and opting for bankruptcy reorganization.
That leaves bond holders in the lurch, possibly forcing them to accept compromised principle values and possibly eliminating coupon payments, at least for a period.
And even though many beleaguered state and government pension funds have the capability to continue paying benefits for some time, it doesn’t mean that bonds issued with their backing are sound investments.
So if your clients are flocking to shield their income through tax-free investments, it might be a good idea to increase your due diligence
based on the ability of municipalities to meet their future obligations rather than on the broader historic default ratio.