Table of Contents

Municipal Bond Fund

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Updated June 11, 2022

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What Is a Municipal Bond Fund?

A municipal bond fund is a fund that invests in municipal bonds. Municipal bond funds can be managed with varying objectives that are often based on location, credit quality, and duration. Municipal bonds are debt securities issued by a state, municipality, county, or special purpose district (such as a public school or airport) to finance capital expenditures. Municipal bond funds are exempt from federal tax and may also be exempt from state taxes.

Key Takeaways

Municipal bond funds invest in municipal bonds, debt instruments issued by state and local governments to help fund capital projects.
Municipal bonds and bond funds are usually exempt from federal taxes, and if they are issued within the state of the purchaser, are also exempt from state taxes.
They often appeal to risk-averse investors by offering slow, steady income, providing a balance during more turbulent times, or in contrast to a riskier stock portfolio.

How a Municipal Bond Fund Works

Municipal bond funds are one of a few investments in the market that offer tax exemption. For investors, they offer yield and can be a good fixed income option for conservative portfolio allocations.

Municipal bond fund holdings vary by the fund’s objective. They are comprised of municipal bonds that offer investors the advantages of municipal bond securities along with diversification against individual issuer risk. Municipal bonds are structured like standard bond investments with coupon payments and a lump sum payment at maturity. Municipal bond funds pay regulator distributions to investors from coupon payments and capital gains. Distributions are determined at the discretion of the fund.

Strategies can vary by location, credit quality, and maturity. Fund companies offer municipal bond funds across the entire credit spectrum. Investment objectives are typically conservative, intermediate, or high yield with consideration for the maturity date.

Municipal Bond Fund Taxes

Municipal bond funds are an attractive option for an investor’s conservative allocation due to their income and tax exemption. They are often sought by high net worth investors in higher tax brackets specifically for their tax exemption advantages.

Funds that primarily invest in municipal bonds are exempt from federal tax and may also be exempt from state tax. A municipal bond fund is exempt from state tax if it is comprised of bonds issued primarily in the state of the investor’s residence.

Municipal Bond Fund Yield

In addition to tax exemption, municipals also offer distributions that make them top investment choices for income investors. Funds pay distributions monthly, quarterly, semi-annually, or annually. A fund’s distributions can be observed by its trailing and forward yield. The trailing yield provides insight on distributions as a percent of the fund’s price over the past twelve months. Forward yield is based on the most recent distribution.

Municipal Bond Fund Investing

The best municipal bond ETFs in Q3 of 2022 include the Invesco VRDO Tax-Free ETF (PVI) which tracks, as its name suggests, the performance of U.S. dollar tax-exempt variable rate demand obligations (VRDOs). Another top performer is the iShares iBonds Dec 2022 Term Muni Bond ETF (IMBK). This ETF tracks the S&P AMT-Free Municipal Series Dec 2022 Index which is composed of investment-grade U.S. municipal bonds maturing between Dec. 31, 2021, and Dec. 2, 2022. A third option is the Invesco BulletShares 2022 Municipal Bond ETF (BSMM). This ETF performed almost the same as IMBK but pays a much lower dividend.