Debt securities are issued from time to time to finance certain types of capital expenditure. One such security is municipal bonds issued by a state, municipality, or county. A debt obligation arises after municipal bonds are issued for facilitating projects that are in the interest of the public. Popular examples of capital expenditure include the construction of highways, bridges, schools, and hospitals among other public interest projects.

Tax-free municipal bonds allow investors to finance projects for infrastructure development, with the tax exemption incentive encouraging a positive cash flow.

Classification of municipal bonds
There are certain benefits, risks, and IRS treatments applicable for tax-free municipal bonds that determine the type of bond available for capital expenditure. Also, the source of interest payments and repayment schedule applicable will classify municipal bonds accordingly.

There are two main classifications of municipal bonds including a General Obligation Bond (GO) and Revenue Bond. GO is issued by any government entity to finance specific infrastructure projects. The interest for GOs is not backed by any revenue income. The interest component from Revenue bonds, on the other hand, are secured by a specific revenue source. The source of income may vary depending on the type of project.

Points to consider before investing in municipal bonds

Analyze and research
There are multiple options and avenues to invest in the market when it comes to tax-free municipal bonds. It is imperative to analyze all the options first and compare factors like annual yield, associated risks, and duration of the tax-free bond funds you plan to invest.

Short term vs. long-term
Creating a long-term portfolio with a better maturity rate will be more beneficial than short-term bond investments. The best way to generate high returns is to find a fund that will take care of all the strategies and invest on your behalf in state and government issued municipal bonds.

Quality of the bond
Always invest in bond funds that have maturity dates. There is a steady decline in the value of investment for bond funds that don’t have maturity dates. A diverse portfolio with tax-free municipal bonds that have maturity dates will provide you with a high return that is exempt from taxation.

Popular avenues to invest in tax-free municipal bonds

T.Rowe Price Summit Municipal Income Fund
When it comes to tax-exempt bond funds, T.Rowe tops the charts in comparison. It is one of the funds that will invest at least 80% of total assets in investment-grade municipal securities with the highest credit rating. You can expect a 3.4% return over a period of one year from this high yielding tax-free municipal bond.

Vanguard Long-Term Tax-Exempt Fund
Vanguard boasts a diverse portfolio of long-term high-quality municipal bonds with an average investment duration of 6-10 years. Although the tax burden from these tax-free bond funds is low, the tradeoff is a lower return that is subject to multiple interest fluctuations over the years. You can still expect a 3.42% of return over a one-year period. Analysts, however, advise against selling the bonds over a short term. The municipal bond is designed to provide sustainable income over a longer duration. Any income is spared from subject to federal income tax rates.

USAA Tax Exempt Long-Term Fund
In comparison to popular tax-free municipal bonds, the United Services Automobile Association’s (USAA) long-term investment offers a high rate of 3.48% on an average. It goes without saying that the risk is high as the municipal bond has a higher yield. One of the primary avenues of USAA’s strategy is to invest in grade securities. Any interest income earned is not included in the gross income otherwise taxable.

Fidelity Tax-Free Bond Fund
Among tax-free municipal bonds, Fidelity has a diverse portfolio of debt issued by the state and local government or even agencies. There are multiple parameters that affect the bonds investment strategy, including credit quality of the issuer of securities, specific features, and the current valuation of securities in comparison to alternatives available in the market. The fund has an average return of 3.27% based on the previous year’s data, making it one of the popular choices for tax-free municipal bonds with a lower net expense ratio.

Columbia Strategic Municipal Income Fund
Among most tax-free municipal bonds funds, Columbia Strategic offers the highest return at 4.37% over the past year. The purpose of the fund is to invest in bonds and debt obligations issued by public entities. While the fund might have a slightly higher expense ratio in comparison to other bonds, it still offers high returns for a decent investment in tax-free municipal bonds.