Munis, however, are issued by state, city and county governments to raise money to pave roads, build schools, repair bridges, erect hospitals or break ground on football stadiums. They can also be purchased as short-term investments, from one to three years. A key difference: municipal bonds are exempt from federal income tax. And if the bond is issued in the state where you live, you won’t have to pay a cent in local or state taxes, either.
You’ll find that most munis generally don’t pay as much interest as Treasuries. Remember, though, that not a dime of the interest you earn from munis will be eaten up by federal taxes.
The calculation to determine the tax-adjusted yield is relatively simple. Divide the yield by your federal tax rate subtracted from 1 (for couples filing joint returns, that’s 15% for up to $42,350 in income; 28% for up to $102,300; 31% for up to $155,950; 36% for up to $278,450 and 36% for any sum above that). For example, if the muni bond pays 4% and you’re in the 36% tax bracket, its taxable equivalent yield is 6.25%, or 4 divided by 0.64 (or 1 minus 0.36).
The same equation works for muni bond funds. Kirkland, who is in the 31% tax bracket, reaped an 11% gain from her Putnam New York muni bond fund. Essentially, her gain on a tax-adjusted basis would come out to 11 divided by 1 minus 0.31, or 15.94%.
In general, municipalities don’t go bankrupt. But there have been instances when localities have defaulted on interest payments or have had their bonds downgraded. For extra protection, seek out munis that have been insured against default by such institutions as the Muni Bond Insurance Agency.
Since it can be difficult to thoroughly examine the world of munis, we recommend that you opt for muni bond funds. Many are offered in a variety of state packages that can help you achieve the greatest tax savings possible.
We again approached Morningstar for a list of the top three municipal bond funds with an average maturity of four years or less, ranked according to their average annual three-year total return. The top performer: the Strong Short-Term Muni Bond fund, which returned investors an average of 5.86% a year.
These have been unnerving times for your local electric or gas company. Not so very long ago, they were simple to understand. The power company was allowed to collect a fixed rate, as set by state regulators. These days, though, legislatures are throwing the group into a brave new world of competition by deregulating the industry. Soon, it seems, several power companies will battle one another to win your business. That kind of rivalry is likely to push prices downward and pinch the profits of even the most stalwart companies.
By and large, such sweeping changes have been slow in coming. For the most part, utilities remain regulated monopolies in most of the country. In deregulated areas, several nimble companies are busy acquiring power plants coast to coast to