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Investing Specialists

Should You Own a Muni Fund?

Unless you're in one of the highest tax brackets, the tax advantages might be smaller than you think.

Investors have been pouring money into municipal-bond funds. For the trailing one-year period ended November 2019, inflows into all municipal-bond fund categories totaled about $95 billion--the highest annual inflow since 2009. Taxable-bond funds still hold far more assets overall, but municipal-bond funds have been gaining ground, with nearly $850 billion in total assets as of Nov. 30, 2019. The appeal of these funds is largely based on their tax-advantaged status. In the wake of the 2018 tax law changes, fewer people can itemize deductions, which makes investment vehicles that help reduce taxable income more compelling.

But before you join the tax-wary hordes, it's worth taking some time to figure out how much--if anything--a municipal-bond fund can actually save you. For most taxpayers, there's no longer a significant yield advantage for muni funds after you take taxes into account. The best way to figure this out is to calculate a taxable-equivalent yield, which allows you to make apples-to-apples comparisons between the aftertax income from taxable and tax-exempt vehicles. To calculate it, take the nominal (or pretax) yield for the tax-advantaged vehicle and divide it by the percentage of income you'll keep after taxes (or 1 minus your tax rate). You can calculate this by hand or by using a bond calculator. The answer represents how much income you would have to receive from a taxable investment to make it more competitive than the municipal choice.

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