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Both municipal bonds and municipal bond funds (also called tax-free income funds) can help you earn income that's exempt from federal tax and, in many cases, state and local income taxes as well.
High-yield tax-free funds. Typically, these funds invest in lower-rated municipal bonds, as rated by a credit rating agency such as Standard & Poor's or Moody's. Lower-rated bonds typically offer higher yields to compensate investors for higher risk. It should be noted that high-yield municipal bonds generally have a greater risk of default due to their lower credit quality. Short- and intermediate-term tax-free funds. As their names suggest, these funds are categorized according to the average maturity of the municipal bonds in which they invest. As a rule, the longer the average maturity of bonds in a bond fund, the greater the income and expected return, and the greater the potential share price volatility. Tax-exempt money funds. By purchasing short-term municipal securities, these funds are managed to maintain a steady $1.00 per share net asset value. An investment in a money fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although money funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in them.
Please note: 1. For investors subject to the alternative minimum tax, fund dividends may be taxable. Distributions of capital gains are generally taxable. 2. Dividends are generally subject to state and local taxes, if any.
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