In contrast to much of 2013, when wary investors drained billions of dollars from municipal bond mutual funds (and lost money on them), investors have poured money back into muni bonds this year and are profiting. In fact, the S&P National AMT-Free Municipal Bond Index gained a strong 5.4% this year through June 15 after losing 3.3% for all of 2013.
Notwithstanding the losses last year, munis generally are safer than corporate bonds. And for most types of muni bonds, their interest is exempt from federal income tax and possibly state income tax in the state you live in.
But to be safe, you have to follow some guidelines…
- Focus on high-quality bonds, whether you buy them individually or through funds. Since 1970, the annual default rate on muni bonds rated AA or higher has been 0.01%, or one in
every 10,000 bonds. No AAA-rated muni bond has ever had a default. Currently, 13 of the 50 states carry AAA credit ratings. In general, the budget outlook for states and cities has strengthened considerably, thanks to spending cuts, pension reform and higher-than-expected tax revenue.
- Be cautious about long-term muni bond funds. Funds with bonds that don’t mature for many years could suffer the most when interest rates jump. That’s because the more interest rates rise, the less an older bond with a lower rate is worth when it is sold. If you prefer the convenience and professional management of a bond fund, consider the iShares National AMT-Free Muni Bond ETF (MUB), an exchange-traded fund that tracks the intermediate-term muni bond index mentioned above. It recently yielded 1.8%.