How to Invest in Tax Free Municipal Bonds

Municipal bonds offer you a way to invest your money without a lot of risk and allow you to avoid paying taxes on your earnings. These are bonds issued by local governments to pay for things such as schools, recreational facilities and sewer systems.

While the return on bonds generally is low, municipal bonds have the bonus of being exempt from federal taxes and likely free from state taxes if the bond is for a project in that state (check with the treasury department of your state government to find out).

 

4 Steps to Invest in Tax Free Municipal Bonds

 

1. Individual bonds are usually bought and sold in over-the-counter (OTC) markets, which consist of securities firms, banks, brokers and dealers who are involved in transactions involving bonds.

You can buy bonds in the primary market, where they are first issued, or in the secondary market (although you’ll probably pay more in broker’s fees). The bonds are usually sold in denominations of $5,000.

 

2. Another option is investing in a bond fund, which is similar to a stock market fund.

A brokerage or securities firm will package a group of individual bonds together in order to reduce the risk through diversification. These funds could be actively managed by the brokerage in order to provide better returns, or they could be an index fund.

When buying into bond funds, you’ll usually pay a fee (besides your investment) to buy the bonds, as well as fees to manage the fund, so make sure you check out all fees and how they’ll affect your investment before you put any money into a fund.

 

3. Money market funds invest in securities that are short-term (three months or less) and highly liquid.

In addition to municipal bonds, money market funds will also invest in short-term U.S. Treasuries (T-bills), CDs issued by banks and commercial paper that is issued by corporations.

Major advantages to buying municipal bonds through a money market fund are the lower cost to invest (as low as $1,000), and the ability to withdraw your money any time.

 

4. Another low-cost way to invest in municipal bonds is through a bond unit investment trust.

These provide a fixed portfolio of bonds that is picked by a professional and remains the same through the life span of the trust. Because the portfolio doesn’t change, you’ll know how much money you’ll earn while you’re invested in the trust, and it also reduces management fees (as opposed to a bond fund).

 

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