How to Compare Tax Free Municipal Bonds

Tax free municipal bonds, also called 'munis' are government bonds that are free from federal taxation. In many states, you can buy tax free municipal bonds which are also free from the state tariff as well. The following article will tell you how to compare tax free municipal bonds with traditional investments.

Difficulty: Moderately Challenging

Instructions

1. Consider GO or General Obligation. General obligation (GO) tax free municipal bonds are used for purchasing new schools, building roads, courthouses and other necessary long term investments. Because the nature of the investment is a necessity and is unlikely to turn out to be unnecessary these are often considered to be a more secure investment.

2. Consider Revenue Munis. Revenue tax free municipal bonds are issued by state and local government sanctions, such as the water company, in order to enhance facilities or processes or even general maintenance. These are less secure because the return is based on the revenue producing probability of the invested party.

3. Once you have decided which type of tax free municipal bonds to invest in, compare them with their taxable counterparts. Here is the formula for doing so:
   
   Yield divided by (1 minus Tax Bracket)
   
   Example:
   
   If you are in the 20% tax bracket and the yield on the tax free municipal bond is 4.5% you would do this.
   4.5/(1-.20)=5.625% taxable yield equivalent

4. Compare the estimated taxable yield with taxable investments. If the tax free municipal bond's taxable yield less than traditional investments then it is better to go with the traditional investment. If it is more than or equivalent then the tax free municipal bond is the better investment.

Tips & Warnings

• If the investing party is non-profit or not for-profit, they are traditionally better off investing in tax-free corporate bonds.
• If the investing party is in a high tax bracket they are usually going to be more successful with tax free municipal bonds.
• Larger investments means a more secure and predictable return on the investment.

[Kilogramm]

on 11/24/2008 Great and detailed write up, thanks for this!