The government is reportedly scrutinizing the tax-exempt status on municipal bonds as it heads into the "fiscal cliff." However, disregarding the favorable tax treatment, muni bonds and exchange traded funds are still attractive investments.
Municipal bonds typically have higher yields compared to other taxable government bonds, and the credit quality will improve along with a strengthening economy, writes Deborah Levine for MarketWatch.
"With a reasonably favorable credit environment for municipalities, we still expect muni bonds will be the place to be," Matt Tucker, head of fixed income strategy at iShares, said in the article.
"The role you expect muni bonds to play in your portfolio should not be for capital appreciation, but to provide income and diversity," Tucker added.
Currently, the triple-A, 10-year munis yield about 1.76%, or about as much as Treasury yields, but they are more worthwhile for those in higher tax brackets. According to Bank of America Merrill Lynch, municipal bonds in general have returned 7.2% on average so far in 2012, with an effective yield of 2.6%. In comparison, Treasuries have returned around 2%, with an effective yield under 1%.
"Once you decide what your allocation to fixed income is, you look for the best alternatives within fixed income -- and munis make the most sense," Thomas Metzold, a muni bond manager at Eaton Vance, said.
As both parties get more creative in tackling the fiscal cliff, tax-free status on munis has come into question. If any changes do occur, it will affect a large number of investors -- over half of all muni bond interest income was claimed by investors with under $200,000 incomes, according to the IRS.
Nevertheless, this tax-exempt topic has been turned down in the past because it was seen as an effective subsidy for the states and benefited citizens.
High-yield municipal bond ETF options include:
- Market Vectors High Yield Municipal Index ETF (HYD): 4.72% 30-day SEC yield
- SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB): 4.16% 30-day SEC yield
Broad municipal bond ETFs include:
- iShares S&P National Municipal Bond Fund ETF (MUB): 1.56% 30-day SEC yield
- SPDR Barclays Capital Municipal Bond ETF (TFI): 1.56% 30-day SEC yield
Max Chen contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.