7 best tax-free municipal bond funds

Tax-free municipal bond funds are a path to higher returns and lower taxes.

  • By Coryanne Hicks,
  • U.S. News & World Report
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

Municipal bonds, sometimes referred to as munis, are issued by various government entities such as states, counties and municipalities. The income from these bond funds is typically exempt from federal taxes and, if issued within your state, the interest will also be free of state income taxes. This means that municipal bond investors don't need to pay tax on the income from these funds. Frequently, these tax-free bond funds pay higher relative interest payments than comparable corporate and government bonds. To check the tax equivalent yield of a corporate or government bond versus a muni bond, you can use a tax-equivalent yield calculator. An investor in the 24% federal tax bracket would need a nearly 4% yield in a normally taxed bond to get the same take-home yield as a 3% municipal bond. Here are seven municipal bond funds to help you thwart taxes and increase income.

iShares National Muni Bond ETF

This national municipal bond fund (MUB) is one of the most popular, with access to more than 4,800 U.S. muni bonds. With MUB's $23.7 billion in assets under management, municipal bond investors have voted for this fund with their pocketbooks. In terms of credit ratings, the fund is predominantly invested in AAA, AA and A investment-grade bonds. Consequently, these high-quality bonds will offer a lower yield than a bond fund that includes investments with lower credit quality. The intermediate-term fund has a weighted average maturity of 5.13 years and a current yield of 1.96%. The 0.07% expense ratio means you get the underlying bonds for next to nothing. MUB makes for an excellent core fixed-income holding in a taxable investment account.

Vanguard High-Yield Tax-Exempt Fund

"Muni bonds are a fee game," says Ron Madey, chief investment officer at Wealthcare Capital Management. Madey says only about 20% of the 185 unique muni bond funds in Wealthcare Capital Management's dataset outperformed their index, and of those that outperformed, only nine funds have fees they can plausibly overcome given the risk they take. It's no surprise then that he likes the Vanguard High-Yield Tax-Exempt Fund (VWAHX). The Investor class shares have a low expense ratio of only 0.17%, but if you have $50,000 to invest you can get an even lower fee of 0.09% for the Admiral shares. "This fund is on the longer side (and) can have up to 20% in below-investment grade bonds," Madey says. But with nearly 3,400 bonds total, the fund is well diversified against single-bond risk. The Admiral shares are currently yielding about 1.64% vs. the Investor shares, which are currently yielding 1.56%.

VanEck Vectors High-Yield Muni ETF

This VanEck fund (HYD) is appropriate for those with a higher risk tolerance. With $3.5 billion in assets under management, the fund has a 30-day SEC yield of 2.53%, which is superior to other bond funds. Those in the 24% federal tax bracket would receive a tax-equivalent yield of 3.33%. The fund owns more than 1,800 issues, providing reasonable diversification against default. The 0.35% expense ratio is also quite competitive. HYD could be a sound addition to a conservative bond portfolio within a taxable account. Monthly distributions offer higher-income individuals regular earnings.

American High-Income Municipal Bond Fund

"Started in 1994, (AMHIX) has provided investors with a high level of current income that is exempt from federal income taxes," says Steve Azoury, financial advisor and owner of Azoury Financial, who includes AMHIX (AMHIX) in his top-three muni funds. It's provided a decent 5.92% return over the past 10 years, outpacing the Morningstar high-yield muni category average by 0.4%. The risk with this fund is that it invests at least half of its assets in securities rated BBB+ or lower, Azoury notes. But you can't get high yields without taking some risk. Investors should also note the 3.75% front-end sales load you'll incur when you first invest, unless your broker waives that fee for you.

Invesco Rochester Municipal Opportunities Fund Class A

Rated the No. 1 high-yield muni fund by U.S. News, Invesco Rochester Municipal Opportunities Fund (ORNAX) is also a good choice for muni investors, Azoury says. Started in 1993, ORNAX has quite the track record to fall back on. It has outperformed the Morningstar municipal category by 2.4% on average over the previous 10 years. At a 0.95% expense ratio, this isn't an inexpensive fund to buy. It also carries a 4.25% front-end sales load, so it's best to only use this with brokerages that waive the sales load for you. "All in all, municipal bonds cannot perform like the broader market, but can balance a portfolio and offer tax savings on the gains," he says.

iShares iBonds Dec 2022 Term Muni Bond ETF

For investors who prefer a stable return of principal at maturity while enjoying the diversification of a fund, this defined-maturity fund fits the bill. IBMK (IBMK) offers exposure to investment-grade muni bonds that mature in 2022. So regardless of whether interest rates rise or fall, you'll get a return of principal in 2022. The diversified fund holds over 1,500 bonds and has a 12-month yield of 1.23%. The management fee is a low 0.18%. Investors seeking to preserve capital for the next year, while receiving a small tax-free bond payment, might consider this fund. IBMK is one of several defined-maturity bond funds available.

Columbia Multi-Sector Municipal Income ETF

This actively managed muni bond fund aims to benefit from the inefficiencies in today's market. Unlike competing funds, which focus on the biggest issuers of debt and may exclude higher-yield munis such as hospital and housing bonds, MUST (MUST) leverages less popular muni bonds. For example, this rules-based muni bond fund seeks to deliver greater returns by including certain exposures to income-generating sectors such as transportation and health care. The three-year-old fund has a 12-month yield of 1.72% and a 0.23% expense ratio. MUST also trades at a 0.26% premium to net asset value, which means investors pay a tiny premium to the bonds' actual worth if purchased now.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

For more news you can use to help guide your financial life, visit our Insights page.


Copyright 2021 © U.S. News & World Report L.P.
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.