The return you earn on municipal bonds depends on a number of factors including, but not limited to:
Coupon - the stated coupon refers to the amount of interest you will be paid on the face value of your bond. For example, if you invest $1,000 in a bond with a 5% coupon, you will receive $50/year, typically paid in two installments every 6 months.
Yield - the yield refers to the internal rate of return on your investment taking into account any premium or discount paid on the face value of the bond. Often, you will see both yield-to-call and yield-to-maturity, which refers to the different returns you will receive whether the bond is called prior to maturity.
Call features - certain bonds have call provisions in which the issuer could redeem bonds earlier than the stated maturity date. In most new issuances, call features don’t come into play until about the 10 year range.
Maturity - the term length of your investment can have an impact on the return. For example, a longer term bonds typically has more interest rate risk than a shorter term bond. Further, if the yield curve is upward sloping, as is normal, you will have a higher coupon and yield the longer you are willing to invest your money.
Market fluctuations - the most basic strategy for investing in municipal bonds is to buy and hold until maturity. By doing so, you are expected earn the yield to maturity stated at the time of purchase on an annualized basis until maturity. There are, however, times at which an investment must be liquidated prior to maturity. If sold, you will be paid at the current market value of your bond. Fluctuations in interest rates could cause the value of your bond to increase, or decrease.
Tax features - because returns on municipal bonds are in most cases tax free, you should measure the returns not simply by taking the yield of the bond, but also taking into account the tax you saved by investing in a municipal bond.
Consult your accountant or check your most recent tax return for your tax rate. The return you earn, adjusted for the tax saved, is known as the Tax Equivalent Yield.
To learn more about municipal bond basics, visit our learning center!