Yahoo Finance The 9 Best Municipal Bond Funds for Tax-Free Income
Line your pockets with municipal bonds.
Municipal bonds, which are issued by government entities such as states and counties, enjoy a special place in the hearts of income investors for one simple reason -- they let investors keep more cash. Municipal bonds are typically exempt from federal taxation. An investor in the top tax bracket (39.6 percent) would need a nearly 5 percent yield in a normally taxed bond to get the same take-home yield as a 3 percent municipal bond. Exchange-traded funds allow investors to gain exposure to a wide swath of municipal bonds to mitigate their risk.
iShares National Muni Bond ETF (ticker: MUB)
iShares' MUB, at nearly $8 billion in assets, is the largest municipal bond ETF on the market. This fund holds more than 3,000 municipal bonds across most of the country; 18 states are represented at 1 percent or more of the fund, with California (23.4 percent) and New York (19.7 percent) enjoying hefty overweights. MUB's holdings include healthy exposure across the maturity spectrum, and they're of extremely high credit quality, resulting in a modest 2 percent SEC yield, but that blimps up to a 3.4 percent tax-equivalent yield assuming the highest tax bracket.
Expenses: 0.25 percent
SPDR Nuveen Bloomberg Barclays Short Term Municipal Bond ETF (SHM)
The SHM is like MUB in that it has an extremely wide set of high-credit-quality holdings, at well more than 4,000 municipal bonds, 99.9 percent of which are rated Aa or better by Moody's. It also shares a substantial lean toward California (18 percent) and New York (15.5 percent) issues. Where SPDR's SHM fund deviates is that it focuses on short-term bonds, which are less sensitive to changes in interest rates. All but roughly 1 percent of SHM's municipal bonds boast maturities of between one and five years. The trade-off is a low 1.2 percent SEC yield, or 2 percent on a tax-equivalent basis.
Expenses: 0.2 percent
VanEck Vectors AMT-Free Long Municipal Index ETF (MLN)
While municipal bonds are free from federal taxation, some are not exempt from the alternative minimum tax. While most funds have varying levels of bonds that aren't taxed under the AMT, MLN's 355 holdings have been chosen due to their AMT-free status. California (19.1 percent) and New York (15.4 percent) play prominently once more, with Texas enjoying a strong 11.8 percent rating as well. Credit quality is strong here, too; more than 90 percent of MLN's holdings sit at A or higher Standard & Poor's credit ratings. The 3.2 percent 30-day SEC yield sits at 5.3 percent on a tax-equivalent basis.
Expenses: 0.24 percent
VanEck Vectors High-Yield Municipal Index ETF (HYD)
Investors interested in a higher overall yield will be more interested in VanEck's HYD, whose 30-day SEC yield is substantial enough at 4.5 percent, but is downright impressive at a 7.4 percent tax-equivalent yield under the highest tax bracket. Of course, to get there, HYD sits pretty far along the maturity slide at about 20 years on average, and credit quality isn't grand, either. Only 30 percent of HYD's bonds are investment grade, and they're a low BBB at that. Junk muni debt is the lion's share of the fund at 46 percent, and the rest is unrated.
Expenses: 0.35 percent
VanEck Vectors Short High-Yield Municipal Index ETF (SHYD)
VanEck's SHYD, then, is something of a compromise. On the one hand, this municipal bond ETF has a decided goal of squeezing some yield out via lower credit quality -- a little more than half of the fund is investment grade, but more than half of that is in BBB-rated debt. Thus, a little less than half of the fund is junk or unrated. However, SHYD cuts back on interest-rate sensitivity with a low average portfolio maturity of about seven years, making this a somewhat safer fund. The 3.3 percent yield is ample, and translates to a 5.5 percent tax-equivalent yield.
Expenses: 0.35 percent
VanEck Vectors CEF Municipal Income ETF (XMPT)
Another popular way to invest in municipal bonds is closed-end funds, which can use leverage to generate even more income from this tax-free area of the bond market. XMPT taps into this niche by investing in 71 CEFs, including top holdings Nuveen AMT-Free Municipal Credit Income and Nuveen Quality Municipal Income Fund, each of which make up about 8 percent of the fund. The upside? A 5.2 percent SEC yield that would require 8.6 percent from taxable bonds to match. The downside? A high expense ratio that reflects the operating expenses from XMPT's closed-end fund holdings.
Expenses: 1.56 percent
iShares iBonds Sep 2020 Term Muni Bond ETF (IBMI)
Some investors like to engage in "bond laddering," which involves purchasing bonds with different maturities, which helps smooth out performance across bull and bear markets. For those kinds of investors, iShares offers the "iBonds" series of exchange-traded funds, which currently includes municipal bond entries for 2017 (IBMF), 2018 (IBMG), 2019 (IBMH), 2020 (IBMI), 2021 (IBMJ) and 2022 (IBMK). IBMI, for instance, holds 813 bonds that mature in 2020. The short-term nature of the fund means a relatively low 1.2 percent SEC yield, or 2 percent tax equivalent.
Expenses: 0.18 percent
PowerShares California AMT-Free Municipal Bond Portfolio ETF (PWZ)
As mentioned before, municipal bonds are exempt from federal tax, though you might have to pay state and local taxes. However, if you pay California state income tax, you would be exempt from paying state taxes on any municipal bond issued in California. Enter the PWZ -- one of just a handful of state-specific bond funds that obviously make a lot more sense for California residents versus the rest of the country. About 93 percent of PWZ's 107 bonds are investment-grade, with the rest unrated. However, an average maturity of about 23 years helps boost the yield to 2.5 percent SEC, 4.1 percent tax equivalent.
Expenses: 0.28 percent
PowerShares New York AMT-Free Municipal Bond Portfolio (PZT)
California and New York typically find themselves as Nos. 1 and 2 in municipal bond funds' geographical weights, so it should be no surprise that along with California funds, there are a couple of New York-focused funds too. PZT is like the PWZ in makeup, with 92 percent of its 47 holdings enjoying an investment-grade rating, and maturity sitting at just a hair under 23 years. Again, this focus on longer-duration bonds is good for the yield, which is about 2.6 percent, or 4.3 percent tax-equivalent.
Expenses: 0.28 percent
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