If you want to invest in a tax-exempt municipal bond fund, you’ll have hundreds from which to select. Key criteria:
- Geography. Funds that hold bonds issued around the country provide diversification, which lowers risk. Funds holding only bonds issued in your state usually deliver income that’s exempt from state (and perhaps local) tax as well as federal tax.
- Your after-tax income probably will be higher from a single-state fund but such funds are riskier because they can lose value if your state’s economy turns down sharply. Such funds work best for investors in high-tax states such as California, New York, and Massachusetts.
- Maturity. Muni funds holding bonds maturing in 20 years or more usually have higher yields and may provide greater long-term returns but they have more risk, too. If interest rates go up, long-term funds probably will lose the most value.
- Quality. Muni funds with low-rated bonds have higher yields but higher risks, too. In 2000, two high-yield muni bond funds run by Heartland Advisors lost 44% and 69% of their value in a single day!