A municipal bond is an IOU issued by a state, country, city, or other local government, often designed to raise money for a particular purpose. A county may issue bonds, for example, in order to borrow money to build a new airport, fix local roads, or expand a park. A municipal bond fund invests in a portfolio of such bonds.
Municipal bonds often pay slightly lower interest rates than other government or corporate bonds. Their popularity stems from their tax advantages. The interest from most municipal bonds is exempt from federal income taxes. Furthermore, you don’t pay state taxes on municipal bonds issued within your own state; and, if you pay local income taxes (as residents of New York City do, for example), you can even find triple tax exempt bonds that are free from local income taxes, too.
To decide whether a municipal bond fund makes sense for you, figure out what tax bracket you are in. (This will depend on your annual income as well as the number and kind of tax exemptions and deductions you enjoy. Any tax advisor can help you determine this.)
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Municipal bond rates indicate the merit of municipal bonds which depends on whether the bond is backed by the full faith, credit, and taxing powers of the municipality or by revenues generated by the municipal facility the bond issue finances.
How bonds work? Bonds are technically loans. They can be from the government, corporations, or municipalities (cities and towns). When you buy a bond, you are essentially loaning money to whomever you are buying the bond from. In return, they pay you a fixed amount of interest over a certain period of time. You get your money and the interest it has earned when the bond matures.
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