Muni Bonds: They're Not Just for Rich People Anymore

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While Washington has passed along a nice tax cut on income, capital gains and dividends, states have been busy doing the reverse: hiking taxes.

But if you want an investment that sidesteps federal, state and maybe even some local taxes, think municipal bonds.

Tax-exempt bonds are historically cheap compared with Treasuries right now. Money has been flowing in Treasuries for their safety. And at the same time, the supply of municipal bonds has picked up as state and local governments try to take advantage of the low rates.

The thinking used to be that you had to be in a high tax bracket in order for muni bonds to be a good investment. But these days, the yields on these securities are so close to those on taxable government bonds, munis make sense for many more people.

How and why should you invest in tax-exempt bonds? Hugh McGuirk, a municipal-bond manager at T. Rowe Price, answers those questions.

First, how do municipals look these days?

McGuirk: Relative to Treasuries, municipal bonds are quite attractive. A 30-year municipal bond is trading at the same yield as the 30-year Treasury. And municipal bonds aren't subject to federal tax.

One two-year municipal bond delivers 89% of the yield of a two-year Treasury. You're far better off in that municipal bond after taxes, regardless of your tax bracket.

But there is a difference in credit quality. There is no better credit than the U.S. government. The U.S. can print money. The state of Maryland and the state of New York cannot.

There's also a liquidity difference. It's easier to sell Treasuries. If you need to sell municipal bonds before maturity, a significant penalty is extracted if you're a small investor. To get an efficient price in the municipal bond market, you have to be selling in increments of a half-million dollars and higher.