Today’s low yields make in-state munis less attractive. Many municipal bond investors prefer bonds issued in their home state, or funds holding such bonds. Such investments can deliver interest that is exempt from state or local income tax as well as federal tax.
However, the average muni fund now yields only 3-3.5 percent. At that level, there is scant benefit to owning in-state munis, and the risks might be great.
Say you invest $100,000 in a national municipal bond fund paying 3.2 percent interest, or $3,200 per year. If your state and local tax rates add up to, say, 6 percent, you’d owe an additional $192 per year (6 percent of $3,200) and net $3,008. You might net a bit more if you can deduct that $192 tax payment on your federal tax return.
Suppose you can buy a fund that holds only in-state bonds, and that fund yields the same 3.2 percent, or $3,200 per year on a $100,000 investment. In many states, you’d keep all $3,200 in interest.
The bottom line, then, is that you’d be ahead by $192 a year with an in-state muni fund, or by even a smaller amount if you save federal income tax by deducting your $192 outlay. For that amount, you are increasing the risk you have with a $100,000 investment. If you load up your portfolio with in-state bonds or funds, any local economic woes may hurt the bonds’ ratings and devalue your holdings.