Municipal bonds: Safety depends on the municipality
-- Q: Is it safe to buy New York and New Jersey municipal bonds?
A: Municipal bonds have been among some of the safest bets investors can make.
With few exceptions, when you lend money to a city, state or local government you can figure you'll get your money back.
But lately investors are worried about things they never worried about before. Just the fact that you're asking whether the debt issued by two of the states with the largest economies shows just how widespread worry has become.
To answer your question, I'd first say that no investment is 100% safe. Not to go too far, but any time you let someone borrow your money, there's a chance you'll get back less than what you loaned. Not acknowledging that would be folly.
Now, we've established that all investments are risky. But what's more important is understanding how risky the investment is and whether that amount of risk if right for you.
Municipal bond investments as a group are among the least risky investments available.
But don't make the mistake of putting all municipal bonds in one basket. There are different types of munis, some of which are riskier than others.
If you're concerned with safety, you want to stick with what are called general obligation bonds. These are bonds that draw on the borrowers' general taxing power. There have been almost no defaults of general obligation bonds in the past 30 years, says Matt Fabian of Municipal Market Advisors.
There are other types of bonds, such as revenue bonds, which depend for repayment on revenue from the specific project they are sold to finance, such as a toll bridge or sports stadium. These are considered more risky.
What if the state is in financial trouble? Many states, notably including California, are struggling with enormous budget shortfalls. So far, the states have been protecting the interests of lenders and instead, are trying to cut costs to balance their budgets. If that trend continues, muni bonds will continue to be a safe investment, Fabian says.
Where Fabian gets worried, is if states or municipalities try to force bondholders to take concessions in order to avoid state layoffs. That's been the case in Jefferson County Ala., he says. And for that reason, if there's any state whose bonds investors should be more guarded about, it's Alabama, he says. If you start to see other areas trying to squeeze bondholders, you should be concerned.
But Fabian is clear: There is no trend so far to hurt bondholders in New York or New Jersey, or even in California. "In California, they're doing everything they can to reassure bondholders to not worry about repayment," he says.
Finally, the riskiness of muni bonds is determined in part on your purpose for investing in them. If you're just hoping to buy munis and hold them for yield and income over a long period of time, you probably don't have much to worry about, Fabian says. But if you're hoping to time the bond market and dart in and out of munis looking for a quick price gain, that could be a risky proposition.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns. Follow Matt on Twitter at: twitter.com/mattkrantz