Municipal bonds are enjoying a moment among investors who are looking for tax-free income, but they should be wary of allowing tax savings to drive their decisions. This week, Wells Fargo Investment Institute highlighted the attraction of muni bonds as the Federal Reserve prepares to trim rates. Bond prices rise as yields fall, and a falling rate environment would result in price appreciation for municipal bonds.
"We remain favorable on municipal bonds, both essential revenue and general obligation bonds, as they have historically been resilient during periods of economic uncertainty," Wells Fargo noted in a report this week. "For investors in higher effective tax brackets, we believe municipal securities are an important part of fixed-income positioning." But that is where investors can make a misstep – one that may cost them valuable income opportunities.
Though municipal bonds generally offer income that's free of federal income taxes – and state taxes if the investor resides in the issuing state – they also come with lower yields compared to other bonds. That's the trade-off investors make for the safety of general obligation bonds, which are backed by the full faith and credit of the issuing municipality. Even exchange traded funds holding municipals will have a lower 30-day SEC yield, compared to their corporate counterparts: The Vanguard Tax-Exempt Bond ETF (VTEB) has a 30-day SEC yield of 3.
64%, while the Vanguard Total Corporate Bond ETF (VTC) has a 30-day yiel.
