Municipal bonds typically have lower yields than Treasury bonds. That s because the interest on Treasuries is subject to federal income tax while interest on munis is tax-exempt. Historically, munis yield around 85% of Treasury yields; thus, when 10-year Treasuries yield around 3%, as they do now, high-quality munis can be expected to yield about 2.5%.
That s not true today, however. For 10-year maturities:
* The highest-quality munis, rated AAA and AA, yield approximately 3%-3.5%.
* A-rated munis now yield over 4%.
* Baa-rated munis, which are still considered investment-grade rather than junk bonds, may yield over 5%.
Thus, tax-exempt munis now have higher yields than taxable Treasuries. There are several reasons for this, but the fear that pension obligations will lead to defaults has been perhaps the most widely-reported. However, most pension obligations for state and local government employees are many years in the future, giving bond issuers time to prepare for those expenses.
Although there are risks in munis, as there are with any investment, most taxpayers should now consider the substantial benefits offered by well-chosen municipal bonds and well-diversified municipal bond funds.
