If you're thinking about buying a municipal bond, the organization that regulates munis wants you to know that you have choices in how you do so. A helpful new resource from the Municipal Securities Rulemaking Board, or MSRB, lays out a number of ways you can participate in the municipal bond market.
1. Use the services of a broker-dealer or a bank department that is a municipal securities dealerAt a full-service broker-dealer, a broker who primarily deals with individual investors is called a private client broker, though may also have a more generic title such as "financial consultant" or "financial advisor." Purchases and sales of municipal bonds though a broker-dealer are preceded by a discussion with the investor, and the investor must give an explicit order to buy or sell securities in a brokerage account.
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As with all types of investment options, broker-dealers have certain required responsibilities to investors when selling municipal securities. For instance, a broker-dealer must disclose to investors all material information about any municipal security it sells and must offer a fair and reasonable price when an investor is buying or selling a municipal security. Full-service broker-dealers charge a fee when they buy or sell bonds for investors. When broker-dealers act "as principal" (that is, they facilitate trades through their own inventory), they charge a "mark-up" when they sell bonds to investors, and a "mark-down" when they buy bonds from investors. When broker-dealers act "as agent" (that is, help find a buyer or seller who trades directly with the investor), the fee is called a "commission." The MSRB brochure has valuable information about mark-ups and mark-downs -- and other types of fees brokers may charge.
2. Hire an investment advisor who can locate and trade bonds on your specific instructions or general authorityA registered investment advisor (RIA) manages accounts and makes purchases and sales in accordance with an investor's agreed-upon strategy, without getting individual approval for each transaction. When you hire an RIA, you should get written information that explains both the investment policy that applies to your account and the investment process used by the RIA. RIAs often combine purchases for several clients by trading in larger blocks to obtain a better price. RIAs usually charge a management fee to account holders. Some advisors charge depending on the interest rate environment and the associated interest earnings.
3. Trade directly online through a self-managed accountFor investors who prefer to buy and sell muni bonds on their own, another option is to do so through a self-managed account, also known as "direct online trading," which is done without the assistance of a private client broker or RIA. This is an account held with a broker-dealer, and, like a full-service brokerage account, charges commissions, mark-ups and markdowns. The firm has the same obligations to investors as any broker-dealer, but it may fulfill them differently. For example, disclosure about a particular bond might be electronic-only without any discussion with a private client broker. A self-managed account requires the investor to understand the pros and cons of each transaction.
4. Buy or sell shares in a municipal bond mutual fundBuying shares in a mutual fund that invests in muni bonds is yet another way to participate in the municipal bond market. Mutual funds that fully or partially invest in municipal bonds can be an efficient way to diversify investment holdings. While muni funds can provide built-in diversity in municipal bond investing, you do not own those bonds directly. Instead, you own an equity share of the fund. This is important because interest rate changes have a different effect on the owners of municipal bond mutual funds than on the direct owners of municipal bonds. Many investors who buy individual municipal bonds intend to, and do, hold them to maturity, although the market value of bonds varies between purchase and maturity. But the managers of mutual funds are seeking to maintain a stable or increasing share price. If rising interest rates cause the market value of bonds in the mutual fund portfolio to fall, some of those bonds will be sold -- at a loss -- both to limit further losses and to pay for share withdrawals. As a mutual fund shareholder, you are exposed to potential fluctuations in the mutual fund's value.
5. Buy or sell shares in a municipal bond exchange-traded fund (ETF)ETFs combine aspects of mutual funds and conventional stocks. Most municipal bond ETFs are designed to track an underlying index. Because a municipal bond ETF trades like a stock, its share price can differ from the underlying net asset value (NAV) of the ETF. This can add another level of volatility to the price of a municipal bond ETF that does not exist with a municipal bond mutual fund. When an investor buys or sells shares of a municipal bond ETF, the transaction occurs between investors (buyers and sellers) over the exchange. In contrast, when an investor buys or sells shares in a municipal bond mutual fund, the transaction occurs directly from the mutual fund company. Municipal bond ETFs trade during market hours like a stock. Municipal bond mutual funds can only be bought or sold once a day.
Both mutual funds and ETFs have fees including sales charges, deferred sales charges, and various kinds of shareholder and operating fees. You can compare fund fees and expenses using FINRA's Fund Analyzer.
Regardless of how you participate in the municipal bond market, the MSRB stresses that before you invest in a muni bond, you should consider your investment needs, and ask your financial professional for written information about how fees are charged and which fees apply to your account.
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