The drumbeat of the next presidential election cycle is starting to get louder and louder, and one of the biggest topics on every candidate’s agenda is taxes. Whether to cut or tax certain groups more will undoubtedly be a hot-button issue and could decide ultimately who our next leader is.
But if history is our guide, odds are we’ll all be paying more in the end. That’s why a dose of municipal bonds can be an investor’s best friend.
Munis, which are issued state, county and local governments to fund various programs, come with the bonus of being tax-free when it comes to federal filing. Some munis are free from state taxes as well.
The added bonus is that many municipal bonds offer yields of more than 4%. For someone in the 35% tax bracket, you’d need to earn at least 6.1% to get that amount when factoring in taxes.
So munis are a match made in heaven of high yield and tax-free income. And the easiest way to get your municipal bond fix is through exchange traded funds (ETFs).
Here’s three ETFs that make adding munis a breeze and keep the tax man away:
3 ETFs to Buy for Big Yields on Municipal Bonds: PowerShares National AMT-Free Municipal Bond Portfolio (PZA)
Expense Ratio: 0.28%, or $28 annually per $10,000 invested
Yield: 3.8%
For investors looking for a broad national municipal bonds ETF, the PowerShares National AMT-Free Municipal Bond Portfolio (PZA) makes a great choice. PZA tracks the BofA Merrill Lynch National Long-Term Core Plus Municipal Securities Index, which is made up of muni bonds in the U.S. domestic market with a term of at least 15 years remaining to final maturity.
That means there is no Puerto Rico issued debt in the fund as well as no bonds subject to the nasty alternative minimum tax (AMT).
Currently, the $860 million PZA holds 215 various municipal bonds.
As for the longer duration, investors worried about interest rates shouldn’t fear too much. The tax-free nature of munis makes them a bit more immune from the whims of Federal Reserve. Secondly, most investors in the space buy and hold them to maturity. In fact, most muni bonds rebound quite nicely after any price drop due to rising rates.
That intermediate term spot for PZA’s holdings — currently a duration of five years — produces a 3.8% tax-free dividend yield that is paid monthly. That’s not too shabby at all. Expenses for PZA run a cheap 0.28%, or $28 annually per $10,000 invested.
3 ETFs to Buy for Big Yields on Municipal Bonds: SPDR Nuveen S&P High Yield Muni Bond ETF (HYMB)
Expense Ratio: 0.45%, or $45 annually per $10,000 invested
Yield: 4.5%
Just like companies and individuals, states and municipalities can have less than stellar credit scores. And just like junk bonds, investors require higher yields to own this debt.
That goes likewise for municipal bonds issued for a really special purpose — such as funding a new sports stadium. As such, there’s a whole world of high yield muni bonds and the SPDR Nuveen S&P High Yield Muni Bond ETF (HYMB) is the way to play it.
HYMB tracks the S&P Municipal Yield Index, which is a measure of municipal bonds generally below investment grade. The 445 bonds that HYMB holds produces a hefty 4.5% dividend yield. However, there is some trade-off for that yield.
Aside from the increase risk of default, which is still pretty minimal, HYMB’s holdings could be subject to state and local taxes as well as the AMT. Many special purpose bonds don’t fully qualify for tax-exempt status and can ding high wage earners on their AMT calculations. About 11% of HYMB’s bonds qualify for AMT status.
However, for most of us, HYMB is a great way to pick up a great high yield tax-free. Expenses for the muni bond ETF run 0.45%.
3 ETFs to Buy for Big Yields on Municipal Bonds: Market Vectors CEF Municipal Income ETF (XMPT)
Expense Ratio: 1.65%, or $165 annually per $10,000 invested
Yield: 5.5%
The Market Vectors CEF Municipal Income ETF (XMPT) isn’t like other municipal bond ETFs. That’s because it doesn’t own muni bonds. What it does own is closed-end funds (CEFs) that own muni bonds.
CEFS are a quirky cousin of ETFs and mutual funds. And due to their structure, CEFs can trade at a discount to their underlying values. That discount plus a slight bit of leverage and CEFs feature much larger yields than their respective funds.
XMPT allows investors to own a basket of muni CEFs and all their benefits. The fund places more emphasis on CEFs trading at discounts. This creates a much higher yield and increases the opportunity for capital appreciation for the ETF.
Currently, XMPT holds 85 CEFs, including the Eaton Vance Municipal Income Trust (EVN) and Nuveen Municipal Value Fund, Inc. (NUV).
That mixture of CEFs trading at discounts produces a huge tax-free dividend for the ETF. XMPT currently yields 5.5%. That’s equivalent to a 9.4% yield if you’re in the top tax bracket.
While it may be quirky, investors seriously looking for high income may want to include XMPT on their lists.
As of this writing, Aaron Levitt was long NUV.
