What is a Municipal Bond Fund?

Malcolm Tatum

A municipal bond fund is a type of mutual fund that focuses on the acquisition of municipal bonds as investments. The bonds acquired include any type of municipal bond issued by a city, town, country, parish, state, or federal government. The only limitation on a municipal bond fund is that some type of municipality must issue the bond.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

Investing in mutual funds that are structured as municipal bond funds is attractive to investors for several reasons. First, a fund of this type earns a return from investments that are considered to be extremely stable and highly likely of generating interest income. For investors that do not wish to engage in a great deal of speculation but still want to earn more of a return than could be realized with savings accounts and certificates of deposit, the municipal bond fund provides both safety and the assurance of a relatively decent return.

The municipal bond fund is also attractive due to the fact that many governments do not impose taxes on the interest earned from the bond issues. For example, a bond issue that is issued by a local city or a state may not be subject to taxes from those levels of government. In some situations, the bonds may not be subject to federal taxes as well. A municipal bond fund that includes bonds of this type can be said to provide an investment that is tax-free on more than one level.

While investing in a municipal bond fund is a good option for many investors, it is not ideal for everyone. While it is true the return on municipal bonds is superior to many of the safer investment opportunities, many investors are willing to undertake a greater degree of risk in exchange for the possibility of earning a significantly higher rate of return. Investors who are willing to assume more risk will likely gravitate to such investment options as stocks, or foreign currency trading.

This does not mean that a municipal bond fund cannot result in a decent nest egg over time. When the interest earned from the fund is used to acquire more bond issues, it is possible to incrementally build up a significant financial cushion that can be used later in life, such as the retirement years. While not as spectacular as playing the stock market, the lower volatility does make the municipal bond fund an ideal fit for conservative investors.

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