Municipal bond funds may be one of the most boring investment securities in the universe, but they may be the best funds to own now for the fixed-income portion of your portfolio.
While the financial media and investors focused on rising interest rates and falling prices for junk-bond funds in 2015, they overlooked the positive returns of municipal bonds.
For example, in 2015, the Barclays Aggregate bond index climbed just 0.6%, and the Barclays Municipal bond index jumped 3.3%.
Investors looking for high yields may not be excited about municipal bond funds, but given the price risk of junk bonds, while considering the combination of lower price risk and tax-free income on munis, now can be a good time to consider buying municipal bond funds.
On that note, remember that the income from municipal bond funds is tax-free at the federal level, which makes for a higher tax-equivalent yield. Some investors can benefit further with tax-free income at the state level, if the municipal bonds are issued by the state in which they live.
But the biggest benefit is on the federal level, and a well-managed mutual fund that buys a blend of the best municipal bond funds from around the United States often proves to be a wise move.
With that, we give you the three best funds to buy for municipal bonds:
Best Municipal Bonds Funds: Vanguard High-Yield Tax Exempt (VWAHX)
SEC Yield: 2.59%
Expenses: 0.2%
Minimum Initial Investment: $3,000
Investors looking for a low-cost municipal bond fund that offers a smart balance of yield and return will like what they see in Vanguard High-Yield Tax Exempt (VWAHX).
Beginning with performance, VWAHX beat 95% of intermediate-term national municipal bond funds in 2015 with a gain of 4.1%. And with an average annualized 10-year return of 5%, VWAHX beats 98% of category peers.
As for the yield of 2.6%, you won’t find much higher without taking on higher price risk, interest rate risk, or a combination of both. And remember the tax-equivalent yield? You can calculate it by dividing the yield by one minus your top marginal tax rate. For example, if you are in the 25% federal tax bracket, you would calculate the tax-equivalent yield for VWAHX like this:
Tax Equivalent Yield = 2.6 / (1 – 0.25)
After the math, and the tax savings, you get a yield of about 3.5%. That’s not bad, especially considering the potential for decent returns.
Best Municipal Bonds Funds: T. Rowe Price Tax-Free High Yield (PRFHX)
SEC Yield: 2.96%
Expenses: 0.69%
Minimum Initial Investment: $2,500
For those investors who want a bit more yield without too much added price risk, T. Rowe Price Tax-Free High Yield (PRFHX) is well worth a look.
Although PRFHX is categorized as a high-yield municipal bond fund, the portfolio isn’t heavily allocated to junk bonds. About one-third of the fund’s bond holdings are rated below BBB — the remainder of the portfolio is rated at or above investment grade. This makes for a fund that dips into high yield but not so much as the average high-yield municipal bond fund.
The performance is also worth noting. Although PRFHX fell just short of the category average return in 2015, it still managed an impressive gain of 3.9%, which smashes that of the Barclays Aggregate bond index, which barely moved at 0.6% for the year.
Long-term performance for PRGHX looks most impressive. The 10-year annualized return of 5.1% beats over 90% of category peers, which is noteworthy because it does so without taking excessive risk.
Best Municipal Bonds Funds: USAA Tax Exempt Intermediate-Term (USATX)
SEC Yield: 1.67%
Expenses: 0.55%
Minimum Initial Investment: $3,000
If you want to add a highly rated, well-managed municipal bond fund to your portfolio, USAA Tax Exempt Intermediate-Term (USATX) should make the short list of possible choices.
A central value to this five-star fund is the portfolio manager, Regina G. Shafer, who has been at the helm of USATX for more than 12 years, which is an impressively long tenure in the world of mutual fund management. The fund’s also been around since 1982. So the entire history of USATX goes back three decades and then some.
During her tenure, Shafer can boast a 4.5% annualized return, which beats almost 90% of muni national intermediate-term funds.
Like our other featured municipal bond funds, USATX has a portfolio of bonds that strikes a good balance of moderate risk and intermediate-term durations. In today’s uncertain and volatile market environment, this is the kind of solid mix that fixed-income investors are wise to consider for their portfolios.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.
