Municipal Bond Funds

Municipal bond funds comprise a portion of the investment market that consists of $2.7 trillion U.S. These funds also are lower in risk than many investments. For these two reasons you should consider a municipal bond fund as part of your diversified portfolio.

The Argument for Municipal Bond Funds

In the past, municipal bonds have only held their appeal with high-income investors. The reason for this is due to the fact that the interest payments are generally free from federal income tax. The yield, however, is generally lower than that of a comparable investment in the stock market. For this reason, lower-income investors have shied away from municipal bond funds. That is changing, though because the divide between municipal bonds and Treasury bonds is much smaller, now.

Consider this: A 30-year Treasury bond is yielding approximately 6.35% and 30-year tax free municipal bond funds are yielding around 6.09%. If you are in the 15% tax bracket, the municipal bond yield is equal to that of a 7.16% taxable return on a Treasury bond.

Finding the Best Municipal Bond Funds

The best overall advice for investing in municipal bond funds is to avoid individual munis and seek out diversified or exchange traded funds. Municipal bond ETFs provide investors a vehicle with which to purchase multiple bonds. The decision to be made with these municipal bonds is whether or not to stay within your own state and take full advantage of the tax breaks or to invest in bonds from other states where bond yields are higher due to state or local government finances being shaky. However, this is a double-edged sword and while municipal bonds are historically low-risk investment vehicles, municipalities and the agencies they issue their bonds through, do default on occasion.

Finding the right tax-free municipal bond funds can be challenging due to the amount of research required. Keep in mind that the best municipal bond funds have lower expense rations and fairly strict investment mandates. There are some diversified choices that are great recommendations for anyone interested in testing the muni market. Four great examples are Fidelity Municipal Income (FHIGX), Vanguard Long-Term Tax-Exempt (VWLTX), Vanguard Total Bond Market Index (VBMFX) and Fidelity Intermediate Municipal Income (FLTMX).

Amount to Invest in a Municipal Bond Fund?

Overall, municipal bond funds are a safer investment than stocks, which is why many investors flock to them during times of economic crisis. The question then becomes, how much of my portfolio should I invest? Look at your investment from a goal oriented standpoint. For instance, if you have 10 years before retirement, some investors would say it’s time to go 100%. Some investors will tell you to take 100 and subtract your age and use the result as the percentage to invest. However, at the 10-year point, a good allocation would be about 20%. This can then be added to as you move closer to retirement. As you move toward 5 years pre-retirement, you should scale back on stocks and re-invest in shorter-term or intermediate municipal bond funds.

Tax-free municipal bond funds are a relatively low-risk investment and when used wisely, can be a smart investment for those who are seeking solace in a shaky market.

<< Part 1: Municipal Bonds Overview
Part 3: Buy Municipal Bonds >>
Tim Ord
Ord Oracle

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