Q&A: Investing in municipal bonds

March 6, 2009

I plan to add some bonds or other fixed-income assets to my personal investment portfolio. Would municipal bonds be a good idea?

Q: I plan to add some bonds or other fixed-income assets to my personal investment portfolio. Would municipal bonds be a good idea?

A: Municipal bonds can be issued in any of the 50 states by a number of entities, including territories, subdivisions, counties, cities, towns, school districts, and certain federally sponsored agencies, such as local housing authorities. Historically, the interest paid on these bonds has been exempt from federal income taxes and is generally exempt from state and local taxes in the state of issuance. Because municipal bonds are tax-exempt, investors should only hold them in taxable accounts. Income level and tax bracket are the primary factors to consider when deciding whether taxable securities or tax-exempt municipal bonds will be suitable for your portfolio. If you are in a high tax bracket, municipal bonds might fit well into your portfolio because the interest paid on most municipal bonds is tax exempt. Municipal bonds are priced daily on the open market, so yields change daily. When considering purchasing municipal bonds, you will need to know your marginal federal income tax bracket, so you can determine the after-tax yield for both taxable and non-taxable bond purchases.