Municipal bond ETFs are exchange-traded funds that invest in municipal bonds. A local government or territory, or their agencies, issues these bonds. The fact that interest income is deducted from gross income for federal income tax purposes is one of the most appealing aspects of municipal bonds.
Are municipal bond ETFs risky?
Municipal bond exchange-traded funds (ETFs) offer diversification in the municipal bond market to investors. Municipal bonds, also known as munis, are debt instruments issued by states, municipalities, or counties to fund public capital expenditures such as roadways, bridges, and schools. Municipal bonds often provide tax-free interest income to investors. Despite the fact that many of these bonds are rated “investment grade” by rating agencies, suggesting a low level of credit risk, they are not without danger. By holding debt issued by a wide range of states, municipal governments, and organizations, a municipal bond ETF can help to reduce risk.
Municipal bond prices rose in the first half of November as investors lost faith that President Joe Biden’s $1 trillion infrastructure proposal would result in a flood of new bonds. The scheme is projected to be funded mostly with federal funds, leaving the municipal market largely unaffected.
Which bond ETFs are the safest?
- Over the past year, the investment grade corporate bond sector has lagged the broad US equities market.
- LQDI, IGBH, and LQDH are the best investment grade corporate bond ETFs for Q4 2021.
- The iShares iBoxx $ Investment Grade Corporate Bond ETF is the top holding in the first and third ETFs, while the iShares 10+ Year Investment Grade Corporate Bond ETF is the top holding in the second fund.
Is the IShares National Muni Bond ETF exempt from taxes?
Summary. For low-cost exposure to the investment-grade, tax-exempt bond market, the IShares National Muni Bond ETF MUB is a smart alternative. The interest earned on municipal bonds is not taxed at the federal level.
Are municipal bond exchange-traded funds (ETFs) tax-free?
Are ETFs that invest in municipal bonds tax-free? If municipal bonds ETFs hold exclusively tax-exempt bonds, they are normally tax-free on both the federal and state levels. However, if the municipal bond ETF includes both tax-free and taxable interest, federal and state taxes may be required.
In 2021, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
What exactly is a municipal ETF?
Municipal Bond ETFs are exchange-traded funds that invest primarily in municipal bonds. Local and state governments issue these bonds to fund a variety of projects, including schools, highways, and bridges.
What factors should I consider while purchasing a municipal bond?
Individual municipal bonds are preferred by many investors over municipal bond funds. Individual municipal bonds appeal to them because of the income stability and lack of interest rate risk when purchased and held to maturity. (Learn more about the differences between bonds and bond funds here.)
1. The issuer does not go bankrupt. If you hold a bond until it matures, you will receive your money as long as the bond does not default. With the exception of calls (described below), nothing happens between the time you buy the bond and the maturity date as long as the bond does not default. In the first stage, we’ll show you how to lower your default risk.
2. Obtaining the highest tax-adjusted return – When all other factors are equal, the longer a bond has to maturity, the greater its yield. However, there are a variety of reasons why you might not want to go with the bond with the longest maturity. In step 2, we’ll go over how to pick the correct maturity level.
Your state and local tax rates, as well as whether or not you are subject to the Alternative Minimum Tax (AMT), will all influence your selection when it comes buying municipal bonds.
If you live in a state or city with a high income tax rate, municipal bonds from that state are a good choice.
You may choose to invest in bonds outside of your state if your state and/or city have minimal or no income taxes.
If you’re subject to the AMT, you’ll want to be sure the bonds you buy aren’t subject to it.
More information on this can be found here.
3. The bond will not be called before it matures. You will lose money if you buy bonds that are trading above their face value and they are called. As a general guideline, stay away from bonds that are callable at face value in the next couple of years and are trading at a significant premium to face value.
There is a fast and dirty technique to avoid this situation: avoid bonds with a large yield to worst and yield to maturity difference. While this strategy may cause you to lose out on some good bonds, you will not be startled if your bonds are called.
A sinking fund is included in the pricing of some municipal bonds.
The issuer of a sinking fund is required to pay down sections of the debt at predetermined times.
It’s similar to a call option, but it’s required.
More information about callable bonds and sinking funds can be found here.
4. That the bond is purchased at a reasonable price.
If at all possible, purchase your bonds within the retail order period.
There are no markups and everyone who participates in the retail order period pays the same amount.
If you acquire bonds on the secondary market after they are issued, you must exercise extreme caution to avoid being duped.
You may find out how to engage in retail order periods here, as well as how to avoid getting ripped off in the secondary market here.
Step 1: Decide how much credit risk you are willing to take.
The default rate on rated municipal bonds is extremely low overall. Municipal bonds have traditionally been 50 to 100 times less likely to default than corporate bonds with the same credit rating, as we explore in our essay on municipal bond safety, defaults, and credit ratings.
This isn’t to say that you shouldn’t be concerned about municipal bond default risk.
The vast majority of municipal bonds (in terms of cash value) are rated single A or better.
Bonds rated below single A have a significant decline in quality.
Many smaller bond issuance are also unrated, and unrated bonds have a substantially greater default rate.
Finally, while many bonds are classed as municipal bonds, they do not have the same level of security as bonds backed by a government’s or government entity’s revenues.
With the foregoing in mind, you should always check to see if the municipal bonds you’re buying are:
- Bonds issued by municipalities that are backed by the full faith and credit of the issuing municipality.
- Revenue bonds backed by a project that the issuer’s population are unable to live without.
- Bonds issued to pay items like a city’s power plant and sewage system, the NYC subway system, water systems, and the like are known as “essential service” bonds.
- From the island of Puerto Rico
- (Learn more about Puerto Rico’s municipal bond issues here.)
- Involved in real estate or healthcare– Between 1970 and 2011, revenue bonds from the housing and healthcare industries were responsible for about 75% of defaults.
- Industrial Development Bonds are bonds that are issued to fund a private initiative that is deemed to benefit the general public.
- Bonds issued to fund manufacturing facilities and sports stadiums are two examples.
- The issue is that these bonds are essentially corporate bonds and carry the same level of risk.
Step 2: Look at the yield curve and decide how much interest rate risk you are willing to take.
At Learn Bonds, we update the municipal bond yield curve once a week. These are the rates on the average AAA-rated municipal bond at various maturities. Although the bond you’re looking at may not be rated AAA, the yield curve form for lower-graded bonds should be relatively similar. This is what we’re interested in because we’re just trying to figure out how much extra yield we can achieve by going with longer maturities.
As you can see from the table above, we are now in a period of extremely low interest rates.
The yield curve, on the other hand, is steep, which means you’ll receive more income on longer-term bonds.
The average 10 year AAA rated municipal bond yielded more than 10 times the typical AAA municipal bond with one year till maturity at the time this article was written.
As you move further into the future, the excess return begins to dwindle.
The yield on a ten-year bond, for example, is only around 2.4 times that of a five-year bond.
The yield on the 20-year bond is roughly 1.45 times that of the 10-year bond.
You only get.38 percent extra interest per year if you lock your money away for 30 years instead of 20.
It doesn’t appear to be worthwhile.
You must make your own decision in this case.
The 20-year portion of the curve appears to be the most appealing to me.
You’re still earning enough extra yield to make it worthwhile to prolong your maturities out.
It also depends on how much time you have available.
If you don’t plan on holding the bond for the whole 20 years, you may have to settle for a shorter maturity.
Step 3: Look for Bonds
Learn Bonds’ new concerns with retail order periods website is a smart place to start. This page is updated on a daily basis with the latest editions available for purchase through Fidelity. If you have an account with one of the larger online brokers, you may be able to gain access to certain new issues.
If you can’t find the bond you want there, you can look for it on the secondary market through any of the big internet brokers. The following is an example of E*Trade’s simple screener:
You’ll probably have a lot of bonds to look through after running the basic screen.
The sophisticated screener is located in the upper left hand corner of their results page.
This can be used to filter on a range of factors, including bond type and callability.
Step 4: Choose the bonds you like
After considering the aforementioned reasons, we are admirers of Peter Lynch’s work “Invest in what you know” is a philosophy to follow. You should buy bonds issued by municipalities or for projects that you will be able to track easily whenever possible. For example, because I live in New York City, I will be aware if the MTA is experiencing financial difficulties, which may prompt me to sell the bonds.
Finally, look at the ratings reports for the bonds you’re interested in.
The moody’s or S&P summary ratings reports are usually available through the major internet brokers.
Because the Moody’s reports are significantly superior, we suggest selecting a broker that offers them (E*Trade, Ameritrade, and Schwab all do).
When looking at the ratings report, make sure that the bond and issuer are not on the verge of being downgraded.
In addition to not being on the lookout for a downgrade, we’d want to see that the bond has recently been upgraded.
If you want to go even farther, check out our article “Do-it-yourself credit ratings” is a phrase that means “do it
This course is part of our Free Guide to Municipal Bond Investing Basics. Here’s where you’ll find the next lesson.
They’re usually exempt from federal income tax
Municipal bonds are a popular way to earn tax-free money. They are fixed-income investments that can provide better returns than other alternatives.
The interest on municipal bonds is normally tax-free in the United States. It may even be tax-free in your state or municipality. This benefit allows you to keep a larger portion of your earnings.
Munis are less risky than stocks
Municipal bonds are a low-volatility investing option when compared to other asset classes.
Municipal bond defaults have declined in recent years, so you’re less likely to lose money than if you bought in equities.