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Are tax-free muni bonds right for your portfolio? What to know

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Municipal bonds are a safe and tax-friendly option if you’re in search of a stable asset.

In 2021, demand soared as investors flee from President Joe Biden‘s proposed tax increasesRefinitiv lipper data indicates that net money of record value reached $96.8 Billion into U.S. Mun mutual funds and exchange-traded funds.

Market interest rates are on the rise, which is why they tend to be higher cause bond prices to fallSome investors are concerned about the Federal Reserve’s actions. expected interest rate hikes. Advisors agree that muni bonds can still be a viable option for some clients.

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Safety is one of the main benefits to muni bonds.

Jordan Benold, a certified financial planner, said that Muni bonds were a nice place for clients to put their money. He explained how they are an excellent spot to hold funds while waiting for new opportunities.

According to Moody’s (a bond rating agency), muni bonds are less risky than corporate bonds. There have been 113 defaults on muni bonds from 13,140 issuers between 1970 and 2019, with Moody’s reporting that there were 113 of them.

You can also avoid any federal tax on interest, and you might be exempt from local or state levies. 

California has a higher rate of income than Tennessee. This means that Californians who earn more may have more savings.

Munis don’t make sense for a lot of clients in lower tax brackets because they aren’t saving that much.

Seth Mullikin

Financial advisor, Lattice Financial, LLC

According to Seth Mullikin, CFP, financial advisor with Lattice Financial, LLC, Charlotte, North Carolina, “The lower your income, however, the more tax benefits you will receive.”

He said that munis don’t make much sense to clients who are in lower tax brackets, as they aren’t saving enough. They’re locked with lower yields.”

According to Mullikin, generally, muni bonds can pay off if your income is in the 32% or greater bracket, according to state taxes.

Although muni bonds can pay lower than corporate bonds with similar credit ratings, it is important to evaluate each asset’s post-tax yield in order to make an apples-to–apples comparison. 

Consider, for instance, that you fall within the 35% tax bracket. Let us compare an 8% corporation bond with a 5.25 muni bond. Even though 8% seems like a greater return, it is only 5.2% after Federal Taxes. 

Muni bonds have their downsides

Muni bonds can offer you security and income tax-free, but they may not be suitable if your goal is higher returns. 

Benold advised that you should not enter muni bonds if growth is your goal.

Experts recommend purchasing funds rather than individual muni bonds if you are looking to invest long-term. It may provide more diversification.

It can also be challenging for investors who don’t have the time to track each bond closely for changes in credit or shifts in interest rates.

Additionally, when interest rates fall, issuers may pay off debt earlier to “call” their bond and then resell it at lower yields. This can lead to a lower payout. 

If in doubt you can seek professional advice. This will help to create a muni bonds allocation that is based on your goals, risk tolerance and timeline.

Mullikin said that bonds are meant to protect a portfolio. So you don’t want make any mistakes.”

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