Reduce Taxes by Investing in Municipal Bonds

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While the beginning of the year brings with it the dreaded tax season, there are ways to make it hurt a bit less such as investing in municipal bonds. Municipal bonds are issued by local and state level governments in order to fund their daily activities or provide funding for special projects. They promise big yields with no tax attached at federal or even state level and to maximize gains it is best to focus on municipal exchange-traded funds, also known as ETFs.

Vanguard Tax-Exempt Bond ETF

A new entrant in the ETF field, the Vanguard Tax-Exempt Bond ETF tracks the S&P National AMT-Free Municipal Bond Index, and covers a wide spectrum of investment grade municipal bonds excluding those issued by U.S. territories.

The fund is spread over 675 different municipal bonds, but the benchmark itself holds over 10,000 and is constantly growing, as is the amount in the ETF fund which is currently sitting at around $150 million. With a tax free yield of 1.69 percent, this young ETF has been performing well since its launch in the second half of last year.

SPDR Barclays Short Term Municipal Bond ETF

Another ETF fund worth considering for tax free investment is the SPDR Barclays Short Term Municipal Bond ETF, as it focuses on the shorter term end of municipal bonds by following the Barclays Managed Money Municipal Short Term Index. The 611 investment grade bonds included in this index have the duration of just 2.85 years and this short period gives a certain level of protection against interest rates.

The downside of this ETF is that the yield is not that high, as it only comes out to 0.73 percent. However, factoring in that it is tax free, the yield then becomes equal to a 1.29 percent dividend yield for investors in the highest federal income tax bracket.

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