Who wants tax-free income? It is difficult to find money that comes in and isn’t taxed. However, municipal bonds can be tax-free or tax-exempt. Bonds, by default, do not pay high yields, but they can produce enough to stay ahead of inflation. Let’s get to the bottom of what municipal bonds are and how to employ them.
Municipal Bonds. The Investopedia definition is “A municipal bond, also known as a muni, is debt security used to fund capital expenditures for a county, municipality, or state.” When you invest in municipals bonds, you are investing in your local area or state.
Safety. Municipal bonds are considered relatively safe. The gold standard of safety is Treasury bonds- but munis are generally safer than corporate bonds. Buy munis for the long term.
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Yield. Munis yields right between Treasuries and corporate bonds. The safer the product, the lower the yield. From what I have researched, they generally yield between 3-5%. Again, the yield will depend on the municipality in which you are investing. If a state does not have an excellent financial track record, the bonds will pay a higher yield- because they are riskier.
Taxes. As I mentioned earlier, the main reason to invest in municipal bonds is for the tax benefits. Overall, munis are generally exempt from federal taxes. After that, the tax rate depends on the state or locality. You will have to do extensive research to get the best munis for your situation.
When to buy. High net-worth individuals typically favor munis. They provide these individuals a source of tax-free income. When you are making large sums of money, any tax benefits are welcome. However, anyone can buy munis- if they know-how.
How to buy. You could spend a lot of time researching munis across state lines, or you could have someone do it for you. In my opinion, the best way to buy munis is in the form of municipal bond funds. These funds trade on the stock market and are efficiently dealt with by regular people, like you and me.
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Municipal Bond Funds. Muni Funds are a great way to earn tax-free returns. Remember, since the funds will be tax-free, the yield will be lower than standard bond funds. You can buy municipal bond funds in all flavors- electronic traded funds, closed-end funds, or mutual funds. You can decide which type of fund and which individual funds are best for you. They all have pros and cons, like load fees or expense ratios. Here is a resource from Investopedia to get you started.
How I invest. I just got started with municipal bonds after reading the book “Step-by-Step Bond Investing.” This book also explains the world of bonds, bond funds, and bond closed-end funds. The municipal bond fund that I am investing in is Nuveen AMT-Free Municipal Credit Income Fund (NVG). The current yield for NVG is 4.89%.
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I would eventually like to get 20% of my bond portfolio allocated into tax-free muni bond funds- making a nice little tax break for my portfolio.
Final thoughts. There isn’t too much more to say about municipal bonds. They are hard to acquire outside of bond funds. If chosen correctly, muni bond funds will be tax-free. High net-worth individuals usually favor them. The yield is decent but not earth-shattering. Muni bond funds are relatively safe. Munis are a great way to diversify away from Treasuries and Corporate bonds. Together, they will make a great combination of bonds for your portfolio. Read the article “Stocks vs Bonds: A Beginner’s Guide” to understand why bonds are vital to your portfolio.
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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