ExpertGlossary

Municipal bond mutual funds invest in municipal bonds. Earnings from these funds are always free of federal income tax for all shareholders in the fund.

In addition, some mutual fund companies offer funds that invest exclusively in municipal bonds offered by a single state.

One advantage of muni bond funds is that buyers can invest a much smaller amount of money than they would need to buy a municipal bond on their own. Another advantage of these funds is that they pay income monthly rather than semi-annually.

Municipal bonds are debt securities issued by state or local governments or their agencies to finance general governmental activities or special projects.

For example, a state may float a bond to fund the construction of highways or college dormitories.

The interest a muni pays is usually exempt from federal income taxes, and is also exempt from state and local income taxes if you live in the state where it was issued.

However, any capital gains you realize from selling a muni are taxable, and some muni interest may be vulnerable to the alternative minimum tax (AMT).

Munis generally pay interest at a lower rate than similarly rated corporate bonds of the same term. However, they appeal to investors in the highest tax brackets, who may benefit most from the tax-exempt income.