Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
The overall size of the municipal bond market is over $4 trillion. While this a very large market, an investor’s personal situation combined with the nuances of the municipal bond market can sometimes make it feel much smaller. Investor preferences such as coupon, maturity, call structure, and issuing state can shrink the available investment options considerably. There can be a benefit for investors living in states with high income taxes to purchase municipal issues from their own state, which in most situations avoids state, in addition to federal, taxes. Still, there are many situations where an investor might be better served looking for opportunities nationwide rather than isolating themselves to their home state.
Municipal bond availability and the state tax rate are two of the primary factors used to evaluate the use of in-state or national issues. The chart identifies each state’s highest income tax rate and the total bonds outstanding. Although the $4 trillion municipal market provides a wide range of opportunities, tight personal criteria can eliminate as much as 97%-99% of the total market. For example, Iowa only has ~$26.4 billion in bonds outstanding or just 0.7% of the total market. Searching for only Iowa bonds eliminates 99.3% of the market.
Considering both the state tax rate and the availability can provide a reasonable roadmap for identifying municipal bonds. The lower the state tax rate and the lower the number of total bonds outstanding, the more likely that exploring bonds outside of your home state might make sense. Arizona, for example, has a low state tax rate of 2.5% and only 1.5% of the total bonds outstanding. Looking beyond Arizona-issued bonds opens opportunities. Oftentimes, higher yields for out-of-state bonds more than offset the in-state tax savings gained by purchasing in-state issues. Conversely, investors living in states with high state income taxes are more likely to benefit from in-state issues. A California investor subject to a 13.3% state tax, is likely best served by sticking with California bonds. California also boasts $642 billion bonds outstanding making availability more likely.
Your financial advisor and the Fixed Income Solutions associates will consider your specific situation and whether it is advantageous to look for in-state issues or also seek out-of-state issues that may provide better net income and diversification.
