Debunking the Myth
The view that municipal bonds are only for the wealthy is perhaps a legacy of earlier times when tax-free bonds were heavily sold to wealthy individuals subject to exceptionally high marginal tax rates. Times change.
Today, there are a number of reasons that any investor may want to consider municipal bonds for his or her portfolio, including:
Demand-supply dynamics that may result in favorable tax-equivalent yields, depending on prevailing market conditions and an investor’s combined state and federal tax bracket.
As an effective portfolio diversifier with historically low correlation to many other asset classes.
Lower default rates and reduced refinancing risks, relative to other taxable fixed income sectors. The 10-year average cumulative default rate for all investment grade municipal bonds is 0.10% versus 2.28% for similarly rated corporate bonds.*
Less sensitivity to interest rate environment. Over the past thirty years, for instance, municipal bonds, as measured by the Bloomberg Barclay’s Municipal Bond Index, have delivered positive average monthly returns through all interest rate cycles, although past performance is no guarantee of future results.**
Having an impact. Municipal bonds are issued to fund a wide range of local and state capital investment needs, such as new schools, hospitals, water treatment plants and other important infrastructure. Investors in municipal bonds benefit not only from tax-free income, but additionally from the knowledge that they are helping build and improve their communities.
Tax equivalent yields for municipal bonds versus taxable bonds
Sources: BNY Mellon Investment Management and Morningstar as of June 30, 2019. The yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting. This metric is used to evaluate the worst-case scenario for yield to help investors manage risks. The Tax-Equivalent Yield assumes a federal tax bracket of 37%. Past performance is no guarantee of future results.
US municipals versus comparative corporate issuer (default rates)
Source: Moody’s Investors Service, as of July 2018, average corporate debt recovery rates for senior unsecured bonds 1987-2017.
1 The category shows the average performance of muni cohorts over a 10-year period. A bond that is Investment Grade has a rating of Baa or higher by Moody's. A Speculative Grade has a rating lower than Baa from Moody's Investors Service.
2 Global corporates refers to all non-financial and financial corporates globally as tracked by Moody’s.
5-year correlations among asset classes
Source: BNY Mellon Investment Management and Morningstar, as of June 30, 2019. Past performance is no guarantee of future results.
*Source: Moody’s Investors Service, as of July 2018, average corporate debt recovery rates for senior unsecured bonds 1987-2017.
**Source: Bloomberg as of October 11, 2019. Weekly data, Feb 3, 1989 to Oct 11, 2019.
Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.