Municipal Bonds Funds
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Municipal bonds funds are mutual funds that invest in municipal bonds or Munis. Municipal bonds are debt securities issued by counties, municipalities or states to finance their expenses or building infrastructure. Munis are exempted from federal taxes. They are also exempted from state taxes if the investor is residing in the same state for which the funds are raised. Investors prefer Muni bonds for favorable tax implications. This is especially preferred by people in the high income tax bracket.[br]
Municipal Bonds Funds vs. Taxable Bond Funds
Many investors consider municipal bonds funds as low-yield investment vehicles, when compared to taxable bond funds that offer higher yield. However, if you consider the federal, state and local taxes on the taxable bond funds, Muni funds are likely to offer higher returns. However, an investor may have to pay an Alternative Minimum Tax (AMT) if the capital accumulated through muni bonds funds are used for private activity projects, such as industrial parks, housing projects and hospitals.
Municipal Bonds Funds – Risks
Like any other debt instruments, municipal bonds funds and interest rates are inversely related. That is, when the interest rate increases, the value of a Muni bond fund declines based on the duration of the bonds in the fund. Also, bonds with higher maturity period are more vulnerable to interest rate fluctuations than bonds with intermediate maturity period. Investors can opt for funds that have a good record of risk management. Some funds invest in the highly risky junk bonds. Although these junk bonds may offer higher yield at times, they are not recommended for the risk-averse investor. For those seeking security, it is best to avoid funds that invest in bonds that are highly risky.[br]
The value of bonds and municipal bonds funds are based on changes in interest and inflation rates. Hence, while investing in bond funds be sure to opt for those with a track record of repaying the entire principal amount with interest. Municipal bonds funds need to take greater risk to earn higher returns; although these funds are considered one of the safest fixed income investment options. The crucial element of investing in bond funds is to choose wisely.
