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bonds, doesn't mean you have to pick out the bonds yourself. Just like there are mutual funds comprised of certain sectors of stocks, there are also mutual funds comprised of municipal bonds.

By using a mutual fund, your portfolio is going to be managed by experts in the municipal bond industry. Additionally, you'll get greater diversification for smaller amounts of money than if you try to buy the individual bonds themselves.

The downside of using a mutual fund may be the slightly higher cost of managing the portfolio, as well a greater risk of a decline in value or interest earned. This holds true even if your bond fund buys all AAA-insured municipal bonds, because the mutual fund may be forced to sell some of its position before the bonds actually mature.

2. General Obligation versus Revenue Bonds

There are two main types of municipal bonds, with the difference arising in how money is collected to pay back the interest and principal back investors. The interest that you receive from a general obligation bond is included in a city, county, or state budget. It is funded out of income and sales tax collection, and is one of the municipalities highest obligations.

The interest paid to investors on a revenue bond is funded by some type of underlying municipal enterprise, such as a toll road or water department. If the revenue does not come in, the investors generally do not get paid.

The difference between these two types of bonds becomes negligible if the municipality purchases outside insurance on their bonds. This insurance helps to ensure that even if the county cannot meet its obligations, the investors will still get paid.

3. AAA-Rated versus Lower Quality

One of the great truths of investing is, "the more you risk, the more you can earn". Municipal bonds are no different.

There are cities and counties that are in less than perfect financial shape, and thus they are more likely to default on their bond payments. To entice investors to buy their bonds, they have to offer a higher rate of interest than the safer municipalities.

While there are some very attractive yields on bonds rated less than AAA, you need to consider carefully the interest and principal risk you are assuming. For higher risk bonds such as these, a "high yield" mutual fund is a worthwhile alternative, since it spreads your risk among numerous issuers.

4. Zero Coupon, Taxable, and AMT Municipal Bonds

For investors really looking to maximize their municipal bond return, there are some sophisticated

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