When looking into the municipal bond market, fixed-income investors may be better off with a muni bond exchange traded fund, instead of trading individual debt securities.
Brokers typically mark up the price of municipal bonds they sell to individual investors, writes Aaron Kuriloff for the Wall Street Journal.
However, the markups that funds pay are typically lower since fund companies buy in bulk and are more familiar with the market.
Consequently, Christine Benz, director of personal finance at investment researcher Morningstar, argues that most people should use munis-related bond funds, adding that reducing fees is “absolutely crucial” to efficiently maximize gains from a low-yielding asset like munis.
For instance, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) has a 0.25% expense ratio and a 1.62% 30-day SEC yield and the iShares Short-Term National AMT-Free Muni Bond ETF (NYSEArca: SUB) has a 0.25% expense ratio and a 0.31% expense ratio. [Muni Bond ETFs: Considerations & Factors to Watch]
The SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) has a 0.23% expense ratio and a 1.84% 30-day SEC yield, and the SPDR Nuveen Barclays Short Term Municipal Bond ETF (NYSEArca: SHM) has a 0.20% expense ratio and a 0.54% 30-day SEC yield.
Additionally, since the muni bond ETFs trade like stocks on an exchange, they will be subject to trading fees. However, those using the Fidelity Investment brokerage platform can trade MUB and SUB with zero commission fees, and Charles Schwab’s OneSource program provides commission-free trades on TFI and SHM.
Muni bond investors can also enjoy the instant diversification benefits of owning a muni ETF. The ETFs spread risk by holding multiple bonds from many different issuers across different states. For example, MUB includes 2,364 holdings while TFI has 476 holdings. The large portfolio of muni debt securities help diminish the negative effects of a single issuer default.
Allan Roth, a financial adviser at Wealth Logic, argues that a low-fee broad muni fund helps diversify away from an investor’s local economy and the market for his or her home. However, potential investors should be aware that local tax breaks would only apply to a portion of a broad muni fund that come from their home state.
While municipal bonds have been outperforming this year, investors shouldn’t become too reliant on the asset class. Roth points out that munis make up 10% o the total bond market and warns that many investors have overweight positions in their portfolios. [Muni Bond ETFs May Still Ride Tailwinds]
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.