Municipal Inflation-Linked Securities Definition (2024)

FAQs

What is an inflation-linked security? ›

Inflation-linked bonds, or ILBs, are securities designed to help protect investors from inflation. Primarily issued by sovereign governments, such as the U.S. and the UK, ILBs are indexed to inflation so that the principal and interest payments rise and fall with the rate of inflation.

A municipal bond is a debt obligation issued by a nonprofit organization, a private-sector corporation, or another public entity using the loan for public projects, such as constructing schools, hospitals, and highways.

Municipal securities fall into two categories: 1) municipal bonds issued by states, cities, counties and other governmental entities to raise money to build roads, schools and a host of other projects for the public good; and 2) municipal fund securities.

A major benefit of municipal bonds, or "munis," is that the interest they pay is generally exempt from federal income taxes. They're also generally exempt from state income taxes if the issuer is from the investor's home state.

Suppose an investor owns $1,000 in TIPS at the end of the year, with a coupon rate of 1%. If there is no inflation as measured by the CPI, then the investor will receive $10 in coupon payments for that year. If inflation rises by 2%, however, then the $1,000 principal will be adjusted upward by 2% to $1,020.

Bonds that are linked to inflation are usually offered by federal governments. These fixed-income investments offer investors protection against inflation because they are indexed to inflation. As such, the principal and interest rises and falls with the inflation rate.

Municipal bonds, like all bonds, pose interest rate risk. The longer the term of the bond, the greater the risk. If interest rates rise during the term of your bond, you're losing out on a better rate. This will also cause the bond you are holding to decline in value.

Generally fixed rate municipal bonds pay interest on a semiannual basis such as on June 30 and December 31 of each year. However, municipal bonds can have different payment periods and dates, such as an annual payment.

By purchasing municipal bonds, you are in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or “principal.” A municipal bond's maturity date (the date when the issuer of the bond repays the principal) may be ...

Who regulates municipal securities? ›

The Municipal Securities Rulemaking Board, (MSRB) is the primary regulator of municipal securities issued in the United States. The MSRB sets standards and best practices for both issuers and dealers of munis, as well as mandates transparency of information and disclosure on each issue.

Municipal Securities Rulemaking Board (MSRB)

The MSRB is a self-regulatory organization that is authorized to create rules to prevent fraudulent activity, enhance the efficiency and transparency of the market, and protect investors and the public interest. It regulates broker-dealers, banks, and municipal advisors.

Disadvantages of Municipal Bonds

They typically offer lower yields compared to corporate bonds and stocks. This means that investors may earn less income from their investments. And like all bonds, munis are subject to interest rate risk.

If you sit in the 35% income tax bracket and live in a state with relatively high income tax rates, then investing in municipal bonds (munis, for short) will likely be a better option than taxable bonds. Alternatively, if your income is in the 12% tax bracket, then you may want to steer clear of municipal bonds.

Zero-coupon municipal bonds, which are bought at a discount because they do not make any interest or coupon payments, don't have to be taxed. In fact, most aren't. As long as you're investing in a local municipal bond, taxes won't be a concern. This provides a big advantage over taxable bonds, even with lower interest.

Unlike traditional bonds, TIPS adjust principal and interest payments based on consumer price index changes. TIPS may be advantageous for inflation protection, but they historically underperform stocks in the long run. TIPS are generally seen as a wealth protection tool rather than a wealth-building instrument.

How TIPS protects you against inflation. The principal (called par value or face value) of a TIPS goes up with inflation and down with deflation. When a TIPS matures, you get either the increased (inflation-adjusted) price or the original principal, whichever is greater. You never get less than the original principal.

TIPS are issued by the U.S. Department of the Treasury and are the most well-known type of inflation-linked bonds. They provide investors with protection against inflation as measured by the CPI. TIPS are considered to be low-risk investments, as they are backed by the full faith and credit of the U.S. government.

Social Security benefits, as well as contributions, are linked to changes in inflation over time. The Social Security Administration enacted the COLA in the 1970s in the wake of double-digit inflation. The COLA is based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).