As more people look at options to diversify their investment portfolios, investors should consider including municipal bond exchange traded funds to expand their fixed-income allocations and help manage taxes.
Municipal bonds, or munis, are a type of debt obligation issued by states, cities, counties and other governmental entities. The cities borrow money to build and expand state projects, such as roads and schools. [Muni Bond ETFs’ Moment in the Limelight]
Since muni debt is exempt from federal income taxes and some are exempt from state income taxes, investors can enjoy attractive yields relative to other taxable debt securities.
Instead of going out to purchases individual municipal bonds, investors can use ETFs to track munis, and BlackRock’s iShares points to several reasons why investors should include muni ETFs in their portfolios:
Low cost. Munis are some of the most expensive bonds on the market – investors have to put hundred of thousands if not millions into a single bond to diminish transaction costs. On the other hand, muni ETFs have tight bid/ask spreads, which help cut down trade execution costs. Additionally, ETFs cost around half that of the average muni mutual fund – the 32 muni bond U.S.-listed ETFs on the market show an average expense ratio of 0.34%, and do not charge front- or back-end loads.
Time saver. Muni ETFs provide broad exposure to hundreds or thousands of individual municipal bond securities through a single, easy-to-use investment tool.
Transparency. Munis are traded on the over-the-counter market where buyers and sellers negotiate on a one-one-one basis. With an ETF, muni investors can see prices fluctuate throughout normal trading hours on a stock exchange.
Easy-to-use. ETFs provide deep liquidity and show heavy trading volume, which allow investors to quickly and efficiently execute trades on the open market. With muni ETFs, investors can track broad muni markets through a single trade, like any company share on the stock exchange.
Fixed-income. Muni ETFs, like municipal bonds, provide a steady stream of income, with some paying out monthly distributions.
Tax efficient. Traditional municipal bond mutual funds may incur capital gains distributions. However, ETFs typically don’t incur capital gains distributions because of the way they redeem shares in kind – ETFs don’t sell off positions but usually swap securities for other securities. It should be noted that capital gains distributions can occur in ETFs but are typically less frequent.
Customization. Muni ETFs come in a variety of flavors. Broad muni ETFs help diversify. State-specific ETFs provide targeted exposure and potentially allow some investors to reap state tax benefits. Varying durations allow investors to track munis across the yield curve.
For more information on munis, visit our municipal bonds category.
Max Chen contributed to this article.