Municipal bond funds hold bonds that are issued by state and local governments (and other related entities). Municipal bond funds are generally purchased for the favorable tax treatment given to municipal bonds and the diversification benefits of a mutual fund. But how do you determine if the yield of a municipal bond fund is attractive compared to a taxable bond fund? All else equal, the answer lies in the tax-equivalent yield.
Tax-Free Nature of Municipal Bond Funds
Generally, the income generated within municipal bond funds is tax-free at the federal level. If the fund owns municipal bonds issued in the home state of the investor, then this interest is also tax-free at the state level.
Due to the tax-free nature of municipal bonds, the issuer (in this case the municipalities) can offer a lower yield than taxable bonds (e.g., corporate bonds, US Treasury bonds) with similar characteristics (i.e., maturity, credit quality) while still attracting investors.
A quick calculation of the tax-equivalent yield will help an investor decide if they are a good candidate for a municipal bond fund.
Tax-Equivalent Yield of Municipal Bond Funds
Assuming similar maturity and credit quality, would you rather buy a taxable bond that pays 5% or a tax-free municipal bond that pays 4%? A simple solution is to calculate the tax-equivalent yield. The tax-equivalent yield is the pre-tax yield that the taxable bond must pay in order to equal the tax-free municipal bond yield.
For example, if an investor in the 35% marginal tax bracket is comparing the two above mentioned bonds, the investor would divide the tax-free municipal bond yield by one minus their his/her tax rate:
Tax-Equivalent Yield = .04 / 1 - .35 = 6.15%
The calculation tells us that a 6.15% yield on a taxable bond is equivalent to a tax-free yield of 4%. So, if you are comparing taxable bond funds with municipal bond funds, the tax-equivalent yield is a reasonable place to begin the research process.
You can also multiply the taxable bond yield of 5% by one minus your tax rate (.05 times 1-.35 = .0325). This calculation tells us that a taxable bond yield of 5% is equivalent to a tax-free municipal bond fund yield of 3.25%.
Reach to Municipal Bond Funds
Municipal bond funds are generally attractive to investors in high tax brackets and outside of tax-deferred retirement accounts (e.g., IRAs, 401ks) where tax is deferred on taxable bonds. However, you should use the tax-equivalent yield calculation to determine if the after-tax yield is attractive.
9 Ways to Be Credit Card Smart
Credit cards have turned into an integral part of modern living as they facilitating making purchases and paying bills without carrying cash. They make life easy and help maintain a record of our expenses and help us dispute charges for undelivered and defective things. In addition they enable us to earn reward points. However credit cards could make you overspend and get into debt. There are 9 ways that could help you to be credit card smart.
One can be very smart in playing a game only when he knows the rules of the game very well and follows the same diligently. Similarly to be smart with your credit card you need to know the rules of the credit card usage. Let me unbundle the 9 Ways to Be Credit Card Smart for you.
1) Do not have many credit cards:
It is true that credit cards definitely help in emergencies and facilitate payments. But having too many credit cards could tempt us to overspend and get into credit card debt that could be difficult to recover from. In addition it is best to avail of reward points on one credit card, so that you could encash the points more quickly.
2) Cultivate and maintain an emergency fund:
Most of us believe that credit cards can definitely help in medical and unexpected emergencies, but it is unwise to consider it as a general rule. A much better alternative would be regular setting aside money as an emergency fund for such unexpected emergencies. This will prevent getting into credit card debt.
3) Repayment capacity should determine credit card spending:
It is right that using credit cards in place of cash helps. But this applies to purchases that we can afford only and also repay immediately. Spending more than what you can repay is highly undesirable and could get you into credit card debt.
4) Avoid cash advance withdrawals:
It is best to live within your means and avoid making cash advance withdrawals even in emergencies. This is the worst thing you can do with a credit card. Having a smart spending plan will help you in not falling this trap
5) Avoid bank transfers without valid reasons:
Being credit card smart requires avoiding making balance transfers from one credit card to the other. This will avoid payment of balance transfer fees and getting into further credit card debt that could turn vicious. However transfer of bank transfers like taking advantage of lower interest rates could prove fruitful.
6) Make full payments in time:
Being credit card smart requires you arranging for payment within a month or next billing date. Delay in repayment and minimum payment could affect your credit standing and make you also liable to pay high rates of interest that you could not afford. Not carrying any balance forward would relieve you of stress of getting into credit card debt.
7) Understand the credit card agreement fully:
Being credit card smart requires understanding fully the agreement and other terms and conditions for use of the credit card. This includes understanding transaction fees levied, interest rates, and when increased rates for credit would be charged. This would help take precautions to avoid getting into increased debt on credit cards.
8) Recognize the signs of credit card debt:
Many consider a credit card a boon and fail to realize that they are getting into credit card debt. It is best to understand and recognize signs like skipping a credit bill to pay another, avoiding credit card payment statements, and charging more than your repayment capacity by purchasing luxuries. Failing to cultivate and maintain an emergency fund could also be a cause. Once you recognize these signs you can turn credit card smart.
9) Never lend your credit card:
Being credit smart requires not trusting others with your credit card even if they promise to pay back in time. It is unwise because you will be responsible for the debt and charges. It is quite possible that credit card companies did not allot them a credit card because of certain adverse circumstances.
The last word:
Credit cards can be a boon only when you are credit card smart.
(Source:- www.holisticinvestment.in)