An investor considers adding revenue bonds to her portfolio.
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Revenue bonds are municipal bond issued to finance specific projects like utilities, airports, or toll roads. These bonds differ from general obligation bonds because they are repaid solely from the income produced by the project, such as tolls or fees, rather than tax revenue. Investors favor them for their connection to tangible assets and a unique risk-reward profile compared to other types of municipal bonds.
If you’re considering revenue bonds, a financial advisor can help you determine how they will fit into your portfolio.
Revenue bonds are debt securities issued by municipalities, government agencies or other public entities to fund specific projects that generate income. These bonds differ from general obligation bonds, as they are tied only to the revenue generated by the project they finance, such as a toll road, power plant or public transit system. Issuers do not rely on taxes to repay the bondholders but instead use income like tolls, fees or lease payments.
Revenue bonds are considered project-specific, meaning the success and financial viability of the funded project are key to repayment. This structure often appeals to investors who prefer a direct connection between their investment and a revenue-generating asset.
Revenue bonds function by earmarking specific income streams to cover interest payments and principal repayment. When an issuer sells these bonds, investors provide upfront capital, which is then allocated to the construction or improvement of the revenue-generating project. Over time, income from the project-such as utility bills, bridge tolls or ticket sales-is collected and used to make periodic payments to bondholders.
The repayment structure often includes a trust agreement that outlines how the generated revenue will be managed. In many cases, funds are prioritized for bond repayment before covering operational expenses. Additionally, some revenue bonds are secured by reserve funds or third-party guarantees, offering an extra layer of assurance to investors.
However, these bonds are not risk-free; if revenue from the project falls below expectations, the issuer might struggle to meet payment obligations. This makes due diligence on the project and its revenue projections important for investors.
A financial advisor compares revenue bonds with general obligation bonds for clients.
General obligation (GO) bonds and revenue bonds are two distinct types of municipal securities, each serving different purposes and carrying unique risks. GO bonds are backed by the taxing authority of the issuer, while revenue bonds depend solely on income generated by specific projects.
Below are some of the key differences between these bonds:
Source of repayment: GO bonds are repaid through the general revenue of the issuing entity, including tax revenues like property or sales taxes. Meanwhile, revenue bonds solely rely on income from projects, such as tolls, utility fees or ticket sales.
Risk and yield: GO bonds are generally lower risk due to their tax-backed security, but they tend to offer lower interest rates. Revenue bonds carry higher risk because repayment depends on project success, which can result in higher yields.
Purpose: GO bonds fund general public initiatives like schools, parks and roads, whereas revenue bonds finance specific, self-sustaining projects such as bridges, power plants or stadiums.
Voter involvement: While general obligation bonds often require voter approval due to reliance on taxes, revenue bonds typically do not, as they are not tax-backed.
Retail investors have several ways to buy revenue bonds, including through brokerage accounts, mutual funds specializing in municipal bonds, or directly from issuers during initial public offerings. These bonds are also available on the secondary market, allowing investors to buy and sell them at current prices. For newcomers, investing in municipal bond funds or ETFs can offer a diversified portfolio across different sectors and issuers.
When considering revenue bonds, it’s important to assess the financial stability and revenue potential of the project being financed. Investors should look at the project’s revenue history and forecasts, any reserves set up to protect payments to bondholders, and the bond’s credit rating from agencies like Moody’s or Standard & Poor’s, which indicates the issuer’s ability to fulfill its financial commitments.
Investors should also be aware of the tax implications of revenue bonds. These bonds often come with tax benefits, such as being exempt from federal and sometimes state and local taxes, which can be particularly advantageous for those in higher tax brackets. The specific tax advantages depend on the purpose of the bond and the investor’s location.
An investor reviews her portfolio.
Revenue bonds link repayment to the financial success of specific projects, offering potentially higher yields than general obligation bonds but with greater risk since repayment hinges on the project’s performance. These bonds appeal to investors looking for potential tax benefits and investments connected to real infrastructure projects. However, you should first assess the project’s revenue potential, credit rating and risks to determine whether these investments match your financial goals and risk tolerance.
A financial advisor can help you analyze investment and manage risk for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
