Looking to expand your muni bond portfolio?

Maybe it’s time to look elsewhere.

Investors searching for tax-free municipal bonds traditionally focus on bonds issued in their home state. It makes sense: Most states impose income taxes. For residents of those states, income from munis is only tax exempt if the bonds are issued in their state.

But the muni market is vast. For investors who widen their search, there are opportunities to expand their muni bond portfolio that can more than compensate for the tax consequences and provide diversification as well.

A Smart Way to Expand Your Muni-Bond Portfolio

Understand post-tax returns

Consider, for example, some state-specific muni-fund returns, as illustrated by The Wall Street Journal. Over the past 10 years, funds investing in Colorado, Missouri and Florida bonds averaged an annual post-tax return of 4.07%, 3.89% and 3.78%, respectively.

Over the same period, funds investing in Maryland, Virginia, Michigan and Connecticut bonds have averaged annual returns of 3.06%, 3.24%, 3.31% and 3.34%, respectively.

The difference between the highest annual return and lowest is more than a full percentage point. As the Journal points out, that means the average Maryland fund generates a 35% return over 10 years compared with a 49% return for holders of an average Colorado fund.

Investing in individual bonds, which we prefer, is obviously different than investing in muni funds. But the point is the same: Various factors affect the pricing of tax-free bonds and investors can profit by examining a range of options.

A bigger lens for your muni bond portfolio

Investors who live in the few states with no income taxes are familiar with selecting bonds from a wide array of offerings. It may be time for residents of other states to do the same.

As muni yields are relatively low, we hear from many tax-free income investors who are sitting on their hands – and their money – pining for the day when they will rise (“Finding Bonds When the Muni Supply Is Tight”).

It’s a futile exercise. While those investors wait on the sidelines, generating next to nothing in money-market returns, millions of others continue to reap tax-free income, buying bonds when their funds are available. History shows that when the undecideds jump back into the market, they’ll never make up the income they left on the table during their wait.

There are about 50,000 issuers in the $3.8 trillion municipal bond market, so there are plenty of opportunities for investors to find bonds that suit their objectives. Sometimes, all it takes is a wider lens.

James A. Klotz is the President of FMSbonds, Inc. Email the Author10/14/2020