What You Need to Know About Municipal Bond ETFs

Thinking about including municipal bond ETFs in your portfolio? Then you've come to the right place. We cover a lot of bond ETF topics here, including corporate, junk, treasury, international and muni bond ETFs. So to help you with your research, here is what you can learn about municipal bond funds. So make sure you know all the details.

Municipal Bond ETFs

Cleveland City Hall, Cleveland, Ohio, USA
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Municipal Bond ETFs consist of “muni” bonds, also known as local government bonds. Local governments issue debt in order to raise capital for towns, cities, and counties to help with areas such as urban development, education, etc. In the case of municipal bond ETFs, they track indexes that consist of local government bond products.

Are Municipal Bond ETFs Risky?

Muni Bond ETFs (and US government bonds) are a type of bond ETF that tend to have a lower risk when compared to other bond ETFs like corporate bond funds. Since the bond is backed by a local government, investors feel safer that the government won’t default whereas a corporation may go out of business and default.

However, that’s not to say that a local government can’t default, so no muni bond is without risk, it’s just less likely, so there’s less risk. And I talk a little more about risk in my closing thoughts at the end of this article.

The Benefits of Municipal Bond ETFs

The major benefit of most ETFs is the tax benefit. However, with muni bonds, you are investing in a local government, so muni bond (and ETFs) are tax-free.

However, one caveat to the tax advantage of muni bonds being “tax-free” is the AMT – alternative minimum tax amount. In some cases, the dividend stream from muni bonds is taxable if it falls under the AMT.

To combat that issue, there are municipal bond ETFs like MUNI – the PIMCO Intermediate Municipal Bond Strategy Fund. This municipal bond ETF’s strategy is to include securities that are not subject to the federal AMT.

Speaking of the dividend stream, that is another benefit to muni and other bond ETFs. If your portfolio is wanting some recurring revenue, a bond ETF may be the solution. So another reason to consider them for your portfolio.

Investing in Municipal Bond ETFs

It’s easy to get started with ETFs, which is why they are such a popular investment vehicle. However, before you call your broker, I suggest conducting thorough research. To help you, here is a list of municipal bond ETFs. To find the right fund for your portfolio, look under the hood of each ETF as well as follow their reaction to various market conditions, only then can you decide which muni bond ETF(s) are the best fit for your investing strategy.

The Disadvantages of Municipal Bond ETFs

As I said, there is less risk with muni bonds and therefore less reward. Since municipal bonds are typically safer, the fund will deliver a lower rate of return than other bond ETFs and investments. As always it comes down to a relationship of risk tolerance and desired return.

We touched on the AMT tax issue above, but again, that can be a detriment for some municipal bond ETFs.

Closing Thoughts in Municipal Bond Funds

So hopefully that gives you a better understanding of muni bond funds, how they work, the risks involved, and how they can impact a portfolio.

Keep in mind that while these funds may be attractive, they do have their risks. As do all investments, so make sure you research each new fund or note thoroughly before making any trades. Watch how the funds react to different market conditions. Understand what is in each fund and, if you have any questions or concerns, be sure to consult a financial professional such as a broker or your financial advisor or planner.