With interest rates expected to remain relatively low in 2023, many investors are considering municipal bonds as a way to generate stable income while enjoying tax-exempt interest payments. Often called ‘munis’, these bonds are issued by states, cities and other government entities to fund public projects. A key benefit is that interest earned on most municipal bonds is exempt from federal income taxes and may also be exempt from state and local taxes, making them especially attractive to investors in high tax brackets.
In today’s uncertain market environment, the relative stability and security of municipal bonds continues to draw investors. High credit ratings mean actual defaults are extremely rare, although market fluctuations can lead to short-term price changes. Focusing on essential services bonds and sticking to shorter durations are smart ways to minimize risk. For suitable investors, munis can be an integral part of a diversified 2023 portfolio.
Tax-exempt status gives municipal bonds an advantage for high-tax investors
The biggest appeal of municipal bonds in 2023 stems from their tax-exempt status. For investors subject to high federal and state tax rates, ‘munis’ offer a way to keep more of the income generated from bond investments. The exemptions mean that on an after-tax basis, munis often yield more than comparable taxable bonds like corporate issues. With the Biden administration unlikely to push through tax cuts in 2023, municipal bonds will continue to offer investors substantial tax savings and relatively attractive after-tax yields.
Focusing on highly-rated general obligation and essential services bonds reduces risk
The diversity of municipal bonds means that credit risk varies widely across different offerings. To minimize risk in 2023, investors should focus on general obligation bonds for essential services like sewers, transportation and utilities. These bonds are backed by local taxes and essential infrastructure revenues, giving them high credit ratings and low chances of default. By sticking to highly-rated bonds with strong legal provisions, investors can capture attractive tax-exempt yields with confidence.
Shorter-term municipal bonds limit exposure to rising rate environment
With further Fed interest rate hikes anticipated during 2023, holding shorter-term municipal bonds is a conservative strategy. Limiting duration helps reduce price fluctuation risk if rates keep rising. Laddered bond portfolios holding a range of maturities are particularly popular now for generating steady tax-exempt income. Investors worried about higher rates should focus on bonds maturing in five years or less.
Essential services sector offers stability amid economic uncertainty
Ongoing concerns about a potential recession make municipal bonds focused on essential services especially appealing for conservative investors in 2023. Bonds funding necessities like utilities, transportation, sewers and public health facilities are among the most secure. Economic fluctuations have minimal impact on taxes and fees backing these bonds. Sticking to highly-rated issues in these defensive sectors provides stable tax-exempt income during volatile times.
With advantages like tax-exempt income and low historical default rates, municipal bonds deserve consideration for high-tax investors seeking to balance safety and returns in 2023. Keeping maturities relatively short and sticking to general obligation and essential services bonds rated single-A or higher minimizes risks. For suitable investors, ‘munis’ can play an integral role in balanced, diversified portfolios this year.