Are municipal bonds still a good investment?

That may depend on your situation. Bond prices generally have benefitted greatly over the last few years from low interest rates, and munis have been no exception. Also, income from munis is generally exempt from federal income taxes; that has enhanced their after-tax return relative to corporate bonds or U.S. Treasuries, especially since Treasury yields are at historically low levels.

Some munis, known as private activity bonds, may be subject to the alternative minimum tax. However, if there is no further legislative action to avert impending tax increases scheduled for 2013, the tax advantages of munis are likely to become even more valuable. If investors in higher tax brackets adjust their portfolios to try to minimize next year’s tax bite, increased demand for munis might have a positive effect on prices. (There are no guarantees that will happen, of course, especially given the uncertainty over whether there will be a political bargain to avert the so-called “fiscal cliff.”)

Because many local governments are struggling to balance their books, bankruptcy filings by local governments have increased in the last year. However, they are still extremely rare. According to statistics from the Administrative Office of the U.S. Courts, from June 2011 to June 2012 there were only 17 muni bankruptcy filings compared to 9,285 Chapter 11 filings for businesses, though some analysts have expressed concern that the number could pick up if economic hard times, cuts in federal aid, underfunded pension obligations, and challenges in global credit markets continue to take a toll. So far, dire predictions of disaster in the muni market haven’t come to pass, but the situation is worth keeping an eye on.

Also, remember that current low interest rates won’t last forever. Because bond prices move in the opposite direction from interest rates, when rates do begin to go up, the increase likely will affect the value of all of your bond holdings, including municipals.

Though transparency in muni markets has increased in recent years, bonds can be more challenging to research on your own than stocks. If you’re unsure about whether munis are a good investment for you, or whether you should rethink their role in your portfolio, don’t hesitate to get expert help.