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Investing in tax-exempt municipal bonds is a great idea. But buying them one by one is not.
Individual bonds are issued by airports, water authorities and other community organizations across the country, making it tough to assemble a truly diversified portfolio on your own. And if you ever want to sell your muni bonds, there's not a big market for them. You will pay dearly to dump them.
An easier option is to buy a tax-exempt bond fund. And there are plenty of them out there.If you live in a high-tax state, a fund that's specific to your state is a better choice. A national tax-exempt fund won't give a break on your state taxes, but its income will still be free from federal taxes. And despite the president's recent tax cut on capital gains and dividends, bond interest is still taxed at higher income tax rates. Except for muni-bond income, that is.