According to Morningstar, tax-exempt municipal bond funds now yield 3.5%, on average, while taxable bond funds pay 3.4%. After-tax, you’d be way ahead with muni funds. If you want to invest in a muni fund, though, you should look beyond the current yield to consider:
* Scope. Single-state funds offer interest that’s exempt from state and local income taxes as well as federal income tax.
* AMT exposure. Some municipal bond funds boost yields by buying bonds paying interest that’s subject to the alternative minimum tax (AMT). If you owe the AMT, you may owe income tax on supposedly tax-exempt income.
Costs. Why pay 1% each year (the average for municipal bond funds) for an investment yielding 3.5%? If you shop around, you can find muni funds charging as little as 0.20% a year.
