It's a good idea to invest aggressively for retirement when that milestone is many years away. That generally means loading up on stocks -- if not individual stocks, then investments like S&P 500 index funds that track the broad market.
But as retirement starts getting closer, it's a good idea to get a little more conservative in your portfolio. Once your career wraps up, you may need to tap your portfolio to cover your living expenses in the absence of having a paycheck from work. And so at that point, you'll need to limit the extent to which you're invested in stocks, since stocks can be very volatile.
Now there are different investments you can look at as retirement nears, but generally speaking, bonds are good bet. But that doesn't mean you have to buy corporate bonds. You may, in fact, be better off adding municipal bonds to your portfolio. Here's why.
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Tax benefits and less risk
Corporate bonds -- those issued by companies -- tend to offer higher yields than municipal bonds. But municipal bonds offer one key advantage -- a tax break on your interest payments.
Municipal bond interest is always exempt from taxes at the federal level. And if you buy municipal bonds issued by your state of residence, you won't have to pay state or local tax on that interest either.
Now to be clear, if you sell municipal bonds at a profit, taxes on your capital gains will apply. But you have the potential to enjoy years of tax-free interest payments.
Another benefit of municipal bonds? They tend to be an even safer bet than corporate bonds. This especially applies to general obligation bonds.
Municipal bonds can be broken down into two categories:
- General obligation bonds
- Revenue bonds
Revenue bonds are the riskier option of the two, since they're used to finance projects that are supposed to generate revenue. If those projects don't end up being money-makers, their associated bond issuers may have trouble keeping up with their obligations to investors.
But general obligation bonds are far more secure for one big reason -- they're not used to fund revenue-generating projects. Rather, they're used to do things that benefit the public, like revamp parks and walking trails.
More importantly, general obligation bonds are backed by the full faith and credit of the issuing municipality, which effectively means that issuers can (and are supposed to) do whatever it takes to fulfill their bondholder obligations. And that's a pretty solid guarantee.
Extra income and added security
You absolutely should not unload all of your stocks as retirement approaches. In fact, if you're entering retirement, you can, depending on your circumstances and tolerance for risk, easily keep 50% of your assets in stocks so your portfolio continues to generate solid growth.
But it also pays to look at adding municipal bonds to your personal mix. Doing so is a great way to enjoy a lower-risk investment and a steady stream of interest payments the federal government won't get a piece of.
