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Looking to invest in bonds? Do your research on the various types first; a municipal bond is far different from a taxable bond.

Depending on what you're looking for from your investment (and what tax bracket you're in), municipal bonds could be a good idea for your portfolio. But what makes a municipal bond so different from other sorts of securities, and how can you figure out the yield you'll get from them?

Here's what you need to know.

What Are Municipal Bonds?

Municipal bonds are securities that are issued by a state, city or other form of governmental entity. Sometimes shortened colloquially as "munis," municipal bonds are generally not subject to federal income tax and depending on your circumstances may not be subject to state tax either.

The money you give to a governmental entity in exchange for your municipal bond is put toward public projects. This could mean building schools, roads, bridges or sewers. The entity issuing the bond pays interest payments to the bond recipient in increments until the maturity date of the bond, at which point the holder gets the full amount of money back. If your maturity date is short-term, you could get that money in as little as one year. If it's long-term, you may be investing for a decade.

Municipal bonds are available for any investor to purchase. Commercial banks, insurance companies and investment funds own their fair share, but individual investors are welcome to invest as well. Bond dealers and brokerages offer them, and you can buy directly from whatever government entity is offering them.

Generally, there are two types of municipal bonds: general obligation bonds and revenue bonds.

General Obligation Bonds

A general obligation bond (GO) is a municipal bond that gets repaid by the taxing power of the bond issuer. With a GO bond, no one specific public works project is named as what your investment goes toward, thus you won't get paid via the revenue of a project. Instead, the issuer uses revenue available to them to pay both your interest payments and the full amount of your investment back upon maturity date. That means GOs tend to be perceived as a bit of a safer bet than other municipal bonds, as there are more options for the issuer to find the funds to pay back bonds (increasing tax revenue, issuing out more municipal bonds, etc.)

Revenue Bonds

Revenue bonds, on the other hand, are used to finance specific public works projects, and as the name suggests bond recipients get reimbursed via the revenue that project accrues. For example, the money you use to buy a municipal bond could go toward a stadium for sporting events. You'll be repaid via the revenue the stadium makes. Because the bond is repaid based on a municipality's ability to make revenue through the project, revenue bonds are seen as a riskier investment. If there is no revenue to be had from the project, a bondholder might not be able to fully recoup their investment.

How to Calculate Municipal Bond Yields

In order to do an apples-to-apples comparison between the yield on a municipal bond and a taxable bond, you have to calculate either the taxable-equivalent yield of the municipal bond or the after-tax yield of the taxable bond.

Unfortunately, the instructions can't be boiled down to two simple equations because not all munis are totally tax-free (some are subject to state income taxes) and not all taxable bonds are totally taxable (Treasury bond, note and bill interest are exempt from state income taxes).

However, there are a finite number of scenarios you might encounter. So let's run through them. In all examples, 31% represents the marginal federal tax rate and 6% represents the state marginal tax rate. When you do these calculations for yourself, use your own rates.

The examples assume that your state taxes the interest on municipal bonds issued outside your state. Most states do, but not all do (Indiana doesn't). Some states (Texas, Washington) don't even have an income tax.

Calculating Taxable-Equivalent Yields

If your state does not levy an income tax, you're in luck. To calculate the taxable-equivalent yield of any municipal bond, divide its yield by 1 minus your marginal federal tax rate.

Yield / (1 - 31%)

If your state levies an income tax, the same equation can be used to calculate the Treasury-equivalent yield of a municipal bond issued in your state or the fully taxable-equivalent yield of a municipal bond issued outside your state.

How to calculate the fully taxable-equivalent yield of a municipal bond issued in your state depends on whether you deduct your state tax payment on your federal return.

If you do not deduct, divide the municipal yield by 1 minus your federal rate minus your state rate.

Yield / (1 - 31% - 6%)

If you deduct, you use your effective state tax rate instead, which is your state rate times 1 minus your federal rate.

Yield / (1 - 31% - (6% x (1 - 31%))

How to calculate the Treasury-equivalent yield of a municipal bond issued outside your state also depends on whether you deduct your state tax payment on your federal return. But first you need to calculate the after-tax yield of the municipal by multiplying it by 1 minus your state tax rate.

If you don't deduct your state payment the equation is

(muni yield x (1 - 6%)) / (1 - 31%)

If you deduct it becomes

(muni yield x (1 - (6% * (1 - 31%)) / (1 - 31%)

Calculating After-Tax Yields

The after-tax yield on a Treasury is obtained by multiplying its yield by 1 minus your federal tax rate.

Yield x (1 - 31%)

The after-tax yield on a fully taxable bond depends on whether you take that state income tax deduction.

If you do not take the deduction, multiply the yield by 1 minus your federal rate minus your state rate.

Yield x (1 - 31% - 6%)

If you deduct, you use your effective state tax rate instead, which is your state rate times 1 minus your federal rate.

Yield x (1 - 31% - (6% x (1 - 31%))

Municipal Bond Risks

How risky are municipal bonds as an investment? It depends on the type of risk you're concerned with. Municipal bonds (GOs in particular) are not as likely a default risk as other investments could be, since there are so many safeguards that allow them to be repaid in full. Of course, this isn't a guarantee that the bond won't default, but work has been put in to protect municipal bondholders.

But other types of risk can come into play. Because municipal bonds offer interest payments, they could be subject to interest rate market risk. If interest rates go up, bonds that get issued after yours (which is at a fixed, unchanged rate) could result in a higher yield than your bond. That means if you want to sell before the maturity date, you may not have a lot of buyers looking to take your lower-yield bond.

This article was written by Beth Stanton, a staff member of TheStreet.