Q&A: Taxable vs. tax-free mutual funds

June 18, 2010

Tax-free mutual funds own municipal bonds. Tax-free funds generally provide lower pre-tax returns than taxable counterparts.

Q: Is it better to invest in a tax-free or a taxable mutual fund?

To determine your approximate after-tax rate of return on a taxable investment, multiply your rate of return by 100 percent minus your tax rate. For example, if you are in the 35 percent tax bracket and earn a pre-tax return of 5 percent, your after-tax rate of return would be 3.25 percent. Compare this rate with the tax-free rate on a municipal bond fund to determine relative advantage.

Before investing in a mutual fund, carefully consider its investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund.

Send your money management questions to medec@advanstar.com (please include your regular postal address). Answers to our readers' questions were provided by Leslie Thompson, CFA, CDFA, CPA, partner, Spectrum Management Group, Indianapolis, and Carlo Panaccione, principal, Navigation Group, Redwood Shores, California.