Taxable Bond Funds | Morningstar (2024)

FAQs

Are tax-free bond funds a good investment? ›

These bonds offer a tax advantage because their interest income is typically exempt from federal income taxes and, in many cases, state and local taxes if the investor resides in the state where the bond is issued. Overall, they are considered to be a fairly conservative investment.

Fixed-income funds that distribute income that is subject to taxation at the federal, state, and sometimes local levels.

The main difference between a taxable municipal bond and a tax-exempt muni is that taxable munis pay interest income that's subject to federal and state income taxes, whereas tax-exempt munis pay interest income that's generally exempt from federal and state income taxes.

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

Here are the best low-risk investments in June 2024:

Series I savings bonds. Treasury bills, notes, bonds and TIPS. Corporate bonds.

If the value of your investments drops too far, you might struggle to repay the money you owe the brokerage. Should your account be sent to collections, it could damage your credit score. You can avoid this risk by opening a cash account, which doesn't involve borrowing money.

Treasury bonds and Series I bonds (savings bonds) are also tax-efficient because they're exempt from state and local income taxes. 89 But corporate bonds don't have any tax-free provisions, and, as such, are better off in tax-advantaged accounts.

Buying individual bonds can provide increased control and transparency, but typically requires a greater commitment of time and financial resources. Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.

Unlike individual bonds, which usually make semiannual interest payments, bond funds usually make monthly distributions that can be paid directly to the investor or reinvested into the fund to compound returns.

Should you reinvest dividends in bond funds? ›

There can be tax benefits for reinvesting your dividends because you increase your investment's cost basis over time. 11 Every time you reinvest dividends to buy more shares, the total amount you've spent increases. 12 When you eventually sell your shares, your cost basis will be higher because of this.

Types of Mutual Funds

If any of these stocks pay dividends, then the mutual fund also pays dividends. Similarly, bond funds include only investments in corporate and government bonds. Most bonds pay guaranteed amounts of interest each year, called coupon payments. Because bonds pay interest, bond funds do as well.

How Tax Equivalent Yields Are Calculated. The Tax-Equivalent Yield Calculator uses the following formulas to calculate tax-equivalent yields: Out-of-State Municipal Bond Yield = In-State Muni Bond Yield / (1 – Out-of-State Muni Bond Tax Rate) Treasury Bond Yield = In-State Muni Bond Yield / (1 – Treasury Bond Tax Rate)

You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you're using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including: Tuition.

Interest income generated by municipal bonds is generally not subject to federal taxes, and may be tax-exempt at the state and local level as well, if the bonds were issued by the state in which you live.

The rate of interest offered on tax-free bonds generally ranges between 5.50% to 6.50%, which is fairly attractive when considering the tax exemption on interest for these bonds. A bondholder receives the interest annually.

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.

Although down for the year, munis are outperforming Treasuries, corporates, and the Agg. Source: Bloomberg Indices, as of 3/15/2024. Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. Total returns from 12/31/2023 through 03/15/2024.

Pros of Investing in Treasury Bonds

Tax benefits: The interest income from Treasury bonds is subject to federal income tax but exempt from state and local income taxes. This can be particularly beneficial for investors in high-income tax states, as it allows them to avoid additional taxation on their interest income.