For many investors, municipal bonds are great opportunities to earn income exempt from federal and local taxes. A municipal bond is a loan granted to a local government for the purpose of funding public projects such as parks or highways. Individuals in high tax brackets often find municipal bonds appealing for numerous reasons, most notably the fact that most of these bonds are exempt from most taxes, especially at the federal level. There are two types of municipal bonds, revenue and general obligation, categorized by interest payments and principal repayments. In general, the way in which the loan is repaid largely contributes to its classification.
When large-scale events or scenarios like the coronavirus outbreak come into play, investors may be swayed into adjusting their portfolios, avoiding investments into certain industries, or liquidating specific assets due to their fears and reservations. Municipal bonds are certainly affected, and in these situations, taxable municipal bonds tend to be considered the safer option of the two types.
What Are Revenue Bonds?
The key distinguishing characteristic of revenue bonds is their intended execution and method of repayment. Put simply, revenue municipal bonds are issued for the purpose of funding a project that ultimately generates its own independent revenue. Examples of projects funded by revenue bonds include toll roads, hotels, and hospitals.
What Are General Obligation Bonds?
Where revenue bonds are repaid exclusively through revenue generated from a completed project, general obligation bonds are more flexible in regards to how governments can repay them as well as their intended function. General obligation bonds are issued to fund projects that serve the good of the public, and projects funded by these bonds can include public parks or schools. Rather than rely on generated revenue to repay the bond, governments are expected to repay these loans however they can, and those methods typically rely on taxation. Governments may increase or impose taxes on the community in order to repay lenders.
Which Will Perform Better In Times Like These?
When anxieties surrounding public welfare are high, investors are more likely to opt for more cautious approaches to their finances and subsequent investments. Because of this conservative approach to portfolio management, investors may find that general obligation municipal bonds are the safer option. Taxable municipal bonds, after all, have a lower default rate than other municipal bonds.
Because revenue bonds are reliant on the success of their funded projects, in times of economic uncertainty, governments may not be able to repay investors as quickly or easily as they could during more profitable periods. Puerto Rico G.O.’s are a one example of investors receiving less than one hundred cents on the dollar. High-yield bonds also pose higher risk, and those issued in the travel, health, or hospitality industries may suffer due to societal fears and global crises. While general obligation bonds may not be considered as profitable as revenue bonds in some cases, during global events like the coronavirus outbreak, they can be considered the safer option for investors choosing to invest in municipal bonds.