Fixed income investors who haven’t already strategized about how they want to limit their tax burden in 2024 may want to consider municipal bonds.
Municipal bonds are lauded in the bond markets for their relative stability versus other riskier debt holdings. In addition, with 2024 being an election year, the infrastructure plans of the presidential administration should also garner some interest in munis heading into 2025. However, the prime benefit of munis exists in their tax advantages.
“Their interest income is typically exempt from federal income tax, and potentially state and local taxes if the investor resides in the state where the bond was issued,” a Yahoo Finance article explained, using an example that “a $50,000 investment in municipal bonds yielding 2.89% could save an investor in the 35% tax bracket over $500 in federal taxes annually.”
With recession risks dissipating and the expectation of rate cuts, short-term debt may not have the appeal it did the last few years. But they still have a place in a fixed income portfolio. For example, a short-term bond fund can serve as an option to temporarily park cash and earn interest higher than that offered by a traditional money market account.
That said, consider using the Vanguard Short-Term Tax-Exempt Bond ETF (VTES), which can offer the aforementioned tax benefits. The fund tracks the S&P 0-7 Year National AMT-Free Municipal Bond Index. That index is designed to balance the need for tax efficiency with the need for tax-exempt yield. This balance can translate to potentially higher yields than those afforded by competing strategies, for an appropriate level of duration risk.
A Broad Muni Option
Investors who don’t need to be as strategic with duration can opt for broad exposure. To that end, they can consider the Vanguard Tax-Exempt Bond ETF (VTEB). Unlike VTES, this fund can stretch out further on the yield curve, so duration is higher in order to extract more income.
VTEB tracks the Standard & Poor’s National AMT-Free Municipal Bond Index, which measures the performance of the investment-grade segment of the U.S. municipal bond market. This index includes municipal bonds from issuers, primarily state or local governments or agencies whose interests are exempt from U.S. federal income taxes, and the federal alternative minimum tax.
Of course, a top-of-mind goal for fixed income investors, especially in a year in which rate cuts could happen at a quick pace, is extracting the most yield in the current macroeconomic environment. To that note, VTES offers a 30-day SEC yield of 2.67% (as of January 18), and VTEB brings a yield of 3.21% (also as of January 18).
“Along with these tax benefits, municipal bonds also provide steady, predictable income, making them a viable choice for income-focused investors,” the Yahoo Finance article added. “Moreover, they help to uplift local communities through infrastructure development and job creation, fostering a sense of societal contribution.”
For more news, information, and analysis, visit the Fixed Income Channel.