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Tickers in this Article: SHY, C, MUB, TFI, HYD, XMPT, HYMB, NUV, MYI, SHM
It's tough to be a fixed-income investor these days. With the Federal Reserve continuing to keep interest rates at historically low levels, dividend and interest payments are reflecting that fact. With the cost of living steadily rising and traditional income products like the iShares Barclays 1-3 Year Treasury Bond (NYSE:SHY) paying next to nothing, investors have sought out a variety of non-traditional ways to get their yield "fix". However, one time-honored income solution could be a value bet as dire predictions for the asset class have caused its prices to fall. TUTORIAL: Brokers and Online Trading

The Keys to the City
The boring and unexciting municipal bond market was shaken this year, as some prominent analysts have predicted widespread defaults. Perhaps the most detrimental to the sector was credit analyst Meredith Whitney, who became famous by predicting Citigroup's (NYSE:C) dividend cut. Whitney predicted "hundreds of billions of dollars" of municipal defaults on the TV show "60 Minutes". Meredith's bold prediction fueled a wave of panic selling in the $2.9 trillion market. However, it seems that those predictions may be coming up empty.

Plenty of evidence supports continued gains for the municipal bond sector. Defaults fell 60% in the first half of 2011 compared to last year. Only 24 municipalities defaulted from January through June. This totaled less than $750 million. That compares with 60 defaults and $2.29 billion in the first half of last year and 144 defaults worth $4.89 billion in the first six months of 2009. State budgets are also becoming leaner. According to the National Association of State Budget Officers, states have cut their budgets by 14% since the 2008 recession, and head counts for state employees are at their lowest levels since 1999. As a percentage of the general population, state employment is at its lowest since 1976.

Tax-Free Income
Munis' main appeal is tax-free income. Munis are exempt from federal taxes as well as state tax in the state of issuance. By contrast, treasuries are only free from state and local taxes. Generally, investors in the top three tax brackets will do better in municipal bonds rather than buying a similar treasury issue and paying the tax. Now could be a great time for investors to add the sector. Despite the group's recent outperformance, munis are still relatively cheap versus treasuries. Overall, the term structure for most municipalities, or the timing of their funding needs, is actually better than that of the federal government's.

Adding a Swath of Sewer Bonds
While it is possible for investors to add individual municipal bonds to a portfolio, exchange-traded funds (ETFs) make diversification across the sector easy. After all, the sector still has some default risk. The iShares S&P National AMT-Free Muni Bond (NYSE:MUB) and SPDR Nuveen Barclays Capital Muni Bond (NYSE:TFI) are the two largest ETFs in the sector, yielding a tax-free 3.59% and 3.44%, respectively. These ETFs could be all investors need to add munis to a taxable portfolio. However, there are plenty of other options as well.

For those looking for more income from their muni investment and who are willing to take on more risk, the Market Vectors High-Yield Muni ETF (NYSE:HYD) tracks the lower end of the credit spectrum. Following a junk bond version of munis, the ETF yields 6.2%, or for those in the 25% bracket a tax-equivalent yield of 8.1%. Investors can also choose the SPDR Nuveen S&P High Yield Muni (NYSE:HYMB), which yields 5.98%.

Muni investors have also traditionally been big buyers of closed-end funds. More than half of the fund type focuses on the asset class. The new Market Vectors CEF Municipal Income (NYSE:XMPT) tracks a basket of municipal CEFs, offering investors a chance to own a wide swath of bonds with different management styles. Top holdings for the fund include the Nuveen Municipal Value Fund (NYSE:NUV) and Blackrock MuniYield Insured (NYSE:MYI).

The Bottom Line
For investors seeking income, the boring municipal bond sector might just be what they are looking for. The dire forecasts of massive defaults and bankruptcies seem to be fading. Adding the sector via an ETF like the SPDR Nuveen Barclays Capital S/T Muni Bond (NYSE:SHM) is an easy way to gain access to the asset class. (For related reading, see Weighing The Tax Benefits Of Municipal Securities.)

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