Muni Bond Funds That Work for You

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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.

Watch the Fees

Because the upside in muni bonds is more limited than what you might get from stocks, you should keep the fees to a minimum. Costs are crucial. You can start your hunt by checking out the offerings from the major no-load mutual fund companies. Fidelity, Vanguard and T. Rowe Price all offer solid choices. Here are a few ideas.

Vanguard should always be one of your first stops if you're trying to keep costs down. The firm's funds are cheap. Period. And that certainly includes the firm's tax-exempt funds.

( VWITX) Vanguard's Intermediate-Term Tax-Exempt (VWITX) fund has lower expenses than the vast majority of its peers. And those super-low fees give the fund a performance advantage that's hard to beat. This fund's returns over the last year or so have suffered because of airline-connected investments. The fund hasn't lost money, but it has badly trailed similar funds over the past 12 months. Nevertheless, its long-term record is still solid.

Like Vanguard, Fidelity offers a whole array of tax-exempt bond funds. The fund company runs funds specific to states like California, Florida and Arizona, and manages national funds as well. The ( FLTMX) Fidelity Spartan Intermediate Municipal Income (FLTMX) fund is one of them. This fund focuses on higher-quality muni bonds and also sports low expenses. The only major drawback: You have to cough up $10,000 to get in.

T. Rowe Price is another key stop to make if you're shopping for a tax-exempt bond fund. The fund company has all the right attributes: lots of offerings sporting solid records and low costs. And if you want a fund that invests in both stocks and municipal bonds, T. Rowe has that too. Its ( PRTEX) Tax-Efficient Balanced (PRTEX) fund has half its money in stocks and the other half in tax-exempt bonds. It's a good choice if you only want to buy one fund.

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