Pros and Cons of Municipal Bonds
U.S. stock markets were enjoying an eighth consecutive year of a bull market until volatility toward the end of 2018 erased all of the past year’s gains.1 In times like this, as share prices continue to bounce back and forth on a day-to-day basis, investors close to or in retirement often transition to more conservative investments. One option is the municipal bond market.
The lower the bond quality, the higher the yield tends to be, but as with any investment, choosing the appropriate holding depends on your individual retirement strategy. Even with the lack of volatility, there are downsides to municipal bonds. Their credit quality has waned since the 2008 recession, and many bond investors aren’t getting large enough returns to account for some of the risks. Underfunded pension programs will also make it more difficult for state and local governments to pay out retirement benefits.2
Here are some of the positives of municipal bonds:3
- Returns tend to have a low correlation to traditional asset classes, which make them an excellent choice to help balance and diversify investments in higher-risk assets.
- Less sensitive to interest rate changes than Treasury bonds.
- Tax-exempt status offers a cost-efficient means of income.
Investors interested in using their money to encourage municipal response to climate change may want to consider the green bonds market, which grew from $4.2 billion in 2015 to $7.2 billion in 2016. The only real difference between traditional and green municipal bonds is green issuers regularly monitor and provide confirmation that bond proceeds are used for green projects.4
Another growing sector in the municipal market is Continuing Care Retirement Communities (CCRCs). These senior communities provide a combination of independent living, assisted living and skilled nursing services in a single setting. In many cases, municipalities are issuing municipal bonds to finance CCRC construction and management by not-for-profit entities. While these securities offer the potential for attractive risk-adjusted returns, be aware they typically are not rated by credit rating agencies and require careful research.5
The municipal market requires a high degree of vetting and should be approached with caution. However, several money managers are bullish on municipal bonds for 2019 because of the potential for additional interest rate hikes and increased demand by investors following tax season.6
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1 Sue Chang. Marketwatch. Oct. 24, 2018. “Dow falls 600 points and wipes out 2018 gains; Nasdaq enters correction territory.” https://www.marketwatch.com/story/dow-futures-drop-220-points-as-stock-market-extends-rout-2018-10-24. Accessed Jan. 4, 2019.
2 Robert Almeida and Megan Poplowski. MFS. Aug. 16, 2018. “Shifting Muni Landscape Offers Risk and Potential Reward.” https://www.mfs.com/en-us/insights/shifting-muni-landscape.html. Accessed Jan. 4, 2019.
4 Raymond James. 2018. “Consistent growth of Green Bonds provides options for issuers.” https://www.raymondjames.com/corporations-and-institutions/public-finance/industry-insights/public-finance-market-watch/green-bonds. Accessed Jan. 4, 2019.
5 Robert M. Almeida, Kristen Richardson and Matthew E. Dennehy. MFS. Dec. 18, 2018. “Research Key in Evaluating Senior Living Communities.” https://www.mfs.com/en-us/insights/research-key-in-evaluating-senior-living-communities.html. Accessed Jan. 4, 2019.
6 Amanda Albright. Bloomberg. Dec. 12, 2018. “BlackRock Is Bullish on Muni Bonds Heading Into 2019.” https://www.bloomberg.com/news/articles/2018-12-12/blackrock-comes-out-as-bullish-on-muni-bonds-heading-into-2019. Accessed Jan. 4, 2019.
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