Municipal Bond Funds | Morningstar (2024)

FAQs

Are municipal bond funds a good investment? ›

Investing in municipal bonds is a good way to preserve capital while generating interest. Municipal bonds hold several tax advantages over corporate bonds. Another advantage that munis have over corporate bonds is a much lower rate of default.

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.

Between 1970 and 2022, the cumulative 10-year default rate averaged over that time period was just 0.15%. This includes not only higher rated municipal bonds, but lower grade ones as well. This is why municipal bonds are classified as low-risk investments.

They typically offer lower yields compared to corporate bonds and stocks. This means that investors may earn less income from their investments. And like all bonds, munis are subject to interest rate risk.

The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.

Average Return on Municipal Bonds – 2.12%

The Bloomberg Municipal Bond Index is generally considered to be the municipal bond benchmark. Over the past 10 years it has averaged a 2.12% average annual return, although that figure has fluctuated from a 9.6% high to a -2.6% loss.

Most municipal bonds are issued in a minimum denomination of $5,000, which is typically the smallest amount of a municipal bond an investor can buy or trade.

Interest rate risk.

U.S. interest rates have been low for some time. If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond.

Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes. * You will, however, have to report this income when filing your taxes. Municipal bond income is also usually free from state tax in the state where the bond was issued.

Most municipal bonds and short-term notes are issued in denominations of $5,000 or multiples of $5,000. Bond interest typically is paid every six months (though some types of bonds work differently); interest on notes is usually paid at maturity.

At what income level do municipal bonds make sense? ›

If you sit in the 35% income tax bracket and live in a state with relatively high income tax rates, then investing in municipal bonds (munis, for short) will likely be a better option than taxable bonds. Alternatively, if your income is in the 12% tax bracket, then you may want to steer clear of municipal bonds.

Attractive absolute yields

Like most other fixed income investments, municipal bond yields have risen significantly since late 2021 and are now at levels that largely haven't been reached during the past decade.

Bountiful Yields in High-Quality Credits

As seen below, AAA-A rated municipal credits offer much higher yields than similar-quality corporate bonds and government-backed Treasuries across five-, 10- and 30-year periods.

Average Return on Municipal Bonds – 2.12%

The Bloomberg Municipal Bond Index is generally considered to be the municipal bond benchmark. Over the past 10 years it has averaged a 2.12% average annual return, although that figure has fluctuated from a 9.6% high to a -2.6% loss.

Real yields should remain attractive as central banks maintain higher interest rates while inflation continues to decline. Municipal bond yields started 2024 at their highest level since 2011. In this environment, investors may enjoy attractive total returns from income alone, a dynamic absent for almost 10 years.

Bountiful Yields in High-Quality Credits

As seen below, AAA-A rated municipal credits offer much higher yields than similar-quality corporate bonds and government-backed Treasuries across five-, 10- and 30-year periods.