Written by Matt Benson, CFP®
"How's that S&P Municipal Bond Index holding up?"
I can honestly say I've never heard anyone say that in casual discussion. When we look at our investment offerings for clients though, in certain situations, it may be a very relevant discussion to have because it may constitute a significant part of the solution.
Municipal bonds are debt instruments offered to investors by state and local governments to finance projects, among other things. Historically they have not shown the volatility displayed in our equity markets and the income stream from these investments is federally, and in some cases at the state level, tax free. They provide income, tax efficiency, and are a complementary component to equities as part of a portfolio.
During 2020, the municipal market wasn't really in the spotlight. But that doesn't mean it didn't play an important part. We continually assess this market, along with other markets, to make sure we are using the best tools for each client's situation. Municipal exposure makes up a lot of our client assets and acts as a diversification tool, so it is always a focus for our firm.
As we digest the chart (below) on America’s debt, we always want to be cognizant of where we are positioned for what's next. The graph is fittingly in red and growing rapidly so we have obviously identified it. How do we fix it? There are three ways to address this situation. The first is to spend less. As Americans we have demonstrated a difficulty in doing that at both the personal and governmental level. Another option is to raise taxes. If taxes go up, the demand for tax-free investments like municipal bonds is likely to increase, therefore potentially raising prices. If tax rates go up, the tax-free income generated by these investments is incrementally more valuable as well. The third way is to grow our economy at a healthy pace to turn the tide on that red bar graph.
The bottom line is that we never know exactly what the future will hold, so we construct our investment portfolios carefully, considering many factors. Municipal bonds are just one of the tools in our toolbox to help with diversification.