Investors often focus on stocks when building their investment portfolios, but municipal bonds can offer unique advantages and diversification benefits. Municipal bonds, also known as munis, are issued by state and local governments to finance various public projects. One key advantage of municipal bonds is their tax-exempt status, making them particularly attractive to investors in higher tax brackets.
Here’s a closer look at municipal bonds and some top funds to consider for your investment portfolio.
Understanding Municipal Bonds
Municipal bonds are debt securities issued by governments to raise capital for projects like infrastructure improvements and public facilities. There are two main types of municipal bonds: general obligation bonds and revenue bonds. General obligation bonds are backed by the full faith and credit of the issuing government, while revenue bonds are supported by the revenue generated from specific projects.
Despite their seemingly conservative nature, municipal bonds offer attractive tax benefits. The interest earned on municipal bonds is typically exempt from federal income tax, and in some cases, state and local taxes as well. This tax advantage can make a lower-yielding municipal bond more appealing than a higher-yielding taxable bond when factoring in tax savings.
For example, a high-income earner in the 37% federal tax bracket and 7% state tax bracket may find that a municipal bond with a 3% yield has a tax-equivalent yield of nearly 4.8%, surpassing the yield of a taxable bond.
While municipal bonds are particularly advantageous for high-income investors, they can also benefit those in lower tax brackets. Municipal bonds are generally considered low-risk investments with lower volatility compared to corporate bonds or stocks.
Investing in individual municipal bonds can be complex, which is why many investors opt for municipal bond funds. These funds provide diversification and professional management, reducing the need for individual bond research.
Top Municipal Bond Funds
As of July 17, 2024
Vanguard Tax-Exempt Bond ETF (VTEB)
The Vanguard Tax-Exempt Bond ETF aims to track the performance of the U.S. municipal bond market and offers a high level of federal tax-exempt income.
- 5-year annualized return: 1.2%
- Yield: 3.63%
- Expense ratio: 0.05%
- Total assets: $33.3 billion
Conclusion
Municipal bonds provide valuable tax benefits and diversification for investment portfolios. While they may not offer the same potential returns as stocks, their tax advantages make them a valuable addition, especially for high-income investors. It’s important to consider holding municipal bond funds in taxable accounts to maximize their tax benefits.
Disclaimer: Before making any investment decisions, it’s important to conduct thorough research and consider the advice of financial professionals. Past performance is not indicative of future results.