The past few months have been an interesting time for municipal bonds. Thanks to the drama leading up to the fiscal cliff, these tax-advantaged securities were first in hot demand as a potential safe harbor against tax increases, then experienced a selloff in December amid speculation that their tax-exempt status could be removed for high-income households.
Now that much of the tax uncertainty stirred up by the fiscal cliff has been resolved, munis seem to be back in investors’ good graces.
In fact, now more than ever we may see an uptick in muni bond popularity, since tax rates have increased for all income earners in 2013. Munis tend to pay a lower yield than their corporate bond counterparts, but the income they kick off is exempt from federal income taxes. [Muni Bond ETFs: January Rebound]
So how do investors know if a muni or corporate bond offers a higher yield after taxes? By using the following formula to decipher a muni’s tax equivalent yield (TEY):