Understanding Bonds - Question 90

I'm 68 years old and I understand the benefit of investing in insured tax-free municipal bonds. But are there any disadvantages?

Yes, there are three disadvantages; market risk, inflation risk and call risk. The principal of these bonds is only guaranteed upon maturity.

- If you wish to sell them prior to maturity and interest rates have gone up considerably since you've purchased them, you will find that the principal is less than the purchase price, and you will be taking a loss if you sell them. This is market risk.

- If you hold tax-free bonds until maturity, the money you get back (even though it is equal to the face-value of the bonds) has lost purchasing power over the years because of inflation. Bonds that you've held for thirty years may only have 25% of the purchasing power they had when you purchased them. This is inflation risk.

- When interest rates drop, the issuer of your bonds may wish to call or redeem them and refinance them at a lower rate. This is call risk.