Questions and Responses

Are the tax advantages of municipal bonds worth reduced returns?

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Are the tax advantages of municipal bonds worth reduced returns?

from Teri

A: (Greg) For a tax-free municipal bond to make any sense, you need to be in the right federal tax bracket. Look at your tax return or ask your tax advisor what your marginal tax rate is, then do the following calculation: 

Divide the municipal bond's interest rate by 1 minus your tax bracket. Example: a 5% municipal bond for someone in the 31% tax bracket would yield an equivalent after tax yield of 7.25%. 

Can you find a better yield, even if it is taxable, than 7.25%? If so, than forget the municipal bond.

Be advised! As of this writing, Congress is lowering the tax rates. I am not sure how this will be phased in, but it will have the affect of making tax free investments less valuable.

Municipals primarily provide federal tax relief but sometimes provide exemption from tax in the states where issued. Therefore, if your state and local taxes are super high, you want your own state and local bonds to avoid their taxes. 

Since Texas doesn't have a state income tax, it doesn't matter where your bonds are issued. Look for safe and secure municipalities.

How does an equity index fund work?

from Hake

Q: My wife is a federal government employee, and her 401(k) is invested in Barclays Equity Index Fund. I have read that this is a combination of investments, and I do not understand how it works. I would like to know how to track its performance.

A: (Paul) The fund in which your wife has invested is an index fund based on the Standard & Poor's 500 Index. It’s a collection of the 500 largest stocks in the U.S. market, and this index is often regarded as a proxy for “the market” as a whole.

Your wife’s retirement plan undoubtedly has some literature available that will explain how the fund works. However, it might be useful for you to read a more general book on mutual funds.

Important Disclaimer

Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful. Returns vary and you may have a gain or loss when you sell your shares. Past performance is no guarantee of future results. Index returns shown are historical and include the change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged and do not reflect the impact of transaction costs. Transaction costs would have reduced the total returns.

International investments, especially those in emerging markets, entail greater risks (as well as greater potential rewards) than U.S. investing. These risks include political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less-established markets and economies.

Lastly, the questions and responses set forth here are for general informational purposes only and are not intended to substitute for performing your own independent research or contacting your financial or legal professional before making any investment decisions. We make no guarantees as to the performance of any investment strategy you choose and are not responsible for any losses you might incur.