Investing in bonds is different from investing in stocks in many different aspects, including risks, returns and finally logistics. Here we focus on logistics. You can buy individual municipal issues directly from a broker, or you can purchase shares in a mutual fund that owns a diversified portfolio of municipal bonds.
Buying from a Dealer
Although in buying the bonds directly from a dealer, you are almost guaranteed to get your initial investment (the principal) back if you hold the bond until it matures, one of the drawbacks is that individual municipal bonds are sold in increments of $5,000, and you need a $25,000 minimum investment to get the best price. If you are trying to build a diversified portfolio and do not have a lot of cash, your investment options with bonds are limited. However, do not despair, you can still add bonds to your portfolio by investing in Bond Mutual Funds.
Buying through a Mutual Fund
The advantage of buying bonds through a mutual fund is that you only need $1,000 to get in. However, there is a downside, there is no guarantee that your principal will be returned because a mutual fund owns dozens of bonds that the manager actively trades. So when you sell your fund shares, the value of the investment could be higher or lower than your initial investment, based on the current value of the bonds the manager owns.
Other Tax Considerations
When you buy tax-free bonds (Municipal Bonds or muni), whether you buy them directly or via a mutual fund, remember that the income on the municipal bonds is tax-free but when you cash them out, he capital gain you make on them is taxable.
Also, please note that a muni purchased at a discount has a capital gain at maturity that is subject to tax. On the other hand, a muni purchased at a premium suffers a capital loss at maturity. However that loss cannot be claimed for tax purposes.
