| Municipal bond funds are those which are made up | | | | fund that has the potential of providing a higher |
| of bonds issued by governments and related | | | | yield. |
| organizations at both the local and state level. | | | | However, you should take into consideration the |
| They are very popular due to the favorable tax | | | | pre-tax yield that the bond offers as well. The |
| treatment they receive. | | | | tax-equivalent yield is a calculation which allows |
| Generally speaking, the income that can be | | | | you compare taxable bonds and tax-free bonds |
| generated with a bond fund is tax-free at the | | | | on more equal footing. This is accomplished by |
| federal level. The fund itself owns the bonds | | | | calculating the pre-tax yield of the bond which is |
| issued in a particular state, also making the | | | | taxable so you know what it would have to pay |
| interest tax-free at the state level. Because of | | | | in order to equal the tax-free municipal bond yield. |
| the tax implications of these funds, the | | | | To determine the tax-equivalent yield, you need |
| municipalities issuing bonds included in them are put | | | | to must know your tax bracket. The formula for |
| lower yield bonds on the market but still attract | | | | determining tax-equivalent yield is the interest rate |
| investors. | | | | return percentage of the taxable bond, divided by |
| Determining if funds are the right investment can | | | | one minus your tax bracket percentile. As an |
| often be accomplished by performing a simple | | | | example, let's say you are in the 35th tax bracket |
| calculation of the tax-equivalent yield. | | | | percentile and the bond fund you're considering |
| Understanding the tax-equivalent yield will make it | | | | has a return of 4%. In this case, your calculation |
| easier to determine if a tax-free bond or a | | | | would appear as follows:.04 / 1 -.35 = 6.15% |
| taxable bond offered from another source is a | | | | What this truly tells you is that a taxable bond |
| better investment for you. | | | | would need to have a yield of 6.15% in order to |
| Many investors make the mistake of looking only | | | | be the true equivalent of a tax-free municipal |
| at the interest return rate on bond funds. Due to | | | | bond with a 4% yield. In other words, most |
| the nature of municipal, they tend to have a | | | | investors will find that municipal bond funds |
| lower yield, even if the maturity life and quality of | | | | actually have significant enough tax implications to |
| the bond is otherwise equal to that of a bond | | | | make them a preferred choice over taxable |
| issued elsewhere. This can at first appear to be a | | | | bonds available from other sources. |
| simple choice. Of course you would go with the | | | | |