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The promise of tax-free income, combined with a safety level that's just below Treasury bonds, make municipal bonds a favorite of young and mature investors alike. Yet investing in "muni's" is still as much of an art form as picking the right stocks.

Knowing when to use municipal bonds in your portfolio, as well as what kind to use, will help maximize the overall growth of your net worth. Central to your analysis will be an ongoing awareness of your "marginal tax bracket" at both a Federal and a State level. If you don't know what this percentage is, a simple call to your tax preparer will likely answer the question.

-When To Use Municipal Bonds-

Municipal bonds are ideal for someone who wants the diversification of bonds, and also has a sizable portion of their assets outside of tax-favored accounts such as IRA's or 401k's. This situation is ideal, because the interest earned on municipal bonds is generally tax-free on a Federal and possibly state level.

To make a final determination if municipal bonds should be used, it's necessary to compare the "tax-equivalent yield" on the municipal bonds, to other taxable bonds such as government or corporate bonds. While the formula is fairly simple, the internet abounds with calculators that do the work for you. Be sure to check out the links at the bottom for a couple of examples.

-When Not To Use Municipal Bonds-

With the exception of "AMT" or "taxable muni's", municipal bonds should never be purchased in a tax-sheltered account. Quite simply, you have no need to take the lower tax-free yield of a municipal bond, when the account itself already defers or avoids taxation. In that situation, an investor should take as high of a yield on a taxable bond as their risk profile can tolerate.

You should also minimize the use of municipal bonds (and for that fact, most bonds) if you are looking for double-digit returns out of your investment portfolio. While bonds bring a lot of stability to a portfolio during turbulent times, it's at a cost. The historical rate of return of bonds hovers between 5 7%, while the U.S. stock market is just above 10%.


-How To Invest in Municipal Bonds-

Just because you've decided municipal bonds should be part of your portfolio, doesn't mean your work as an investor is done. There are dozen of varieties of municipal bonds, which provide for some unique planning opportunities and considerations.

1. Individual Municipal Bonds versus Municipal Bond Mutual Funds

Just because you're investing in municipal

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