municipal bond fund
A mutual fund or ETF that invests in tax-exempt municipal bonds, providing diversified exposure to state and local government debt with tax-free income.
Example
“The high-bracket investor chose a municipal bond fund for its tax-free dividends rather than taxable corporate bonds.”
Memory Tip
Muni bond FUND = diversified tax-free income from government bonds. Best for high-tax-bracket investors.
Why It Matters
Municipal bond funds matter because they offer a way to earn investment income that is free from federal income taxes and sometimes state taxes too. For higher-income earners, this tax advantage can significantly boost after-tax returns compared to taxable bond investments.
Common Misconception
Many people assume that municipal bonds and their funds are completely risk-free just because they are backed by government entities. However, these investments still carry credit risk, interest rate risk, and the possibility of default if a municipality faces financial difficulties.
In Practice
An investor in the 32 percent federal tax bracket who earns 3.5 percent interest from a municipal bond fund receives the equivalent of roughly 5.1 percent in pre-tax income from a taxable bond. If the investor lives in a state with high income taxes and buys bonds from their home state, they may also avoid state and local taxes, making the effective return even more attractive.
Etymology
MUNICIPAL (local government) BOND (debt instrument) FUND (pooled investment vehicle).
Common Misspellings
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See Also
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