If you invest in tax-exempt municipals, stick to top-quality bonds. Half of all munis carry a triple A rating, largely because they are insured, which guarantees investors payment of interest and principal even if the issuer defaults.
The four largest muni bond insurers–AMBAC, Financial Guaranty Insurance, Financial Security Assurance, and MBIA–are sound companies that have paid claims in the few instances when issuers have defaulted. Thus, insured bonds should hold their value better if an issuer’s credit rating drops.
With most states facing budget deficits, more credit downgrades are likely this year. Insured bonds trade more actively than other munis so they are easier to buy and sell.
Even with insured bonds, you should take the extra precaution of buying bonds backed by user fees for essential services, such as water and sewage. On the other hand, avoid bonds backed by sales taxes because such revenues shrink during economic downturns.
