Are tax-exempt mutual funds right for you?
Tax-exempt funds are a smart way to reduce your income taxes, but they're not for everyone.
Find out if you could be saving on taxes
Who doesn't want a lighter tax bill? Although tax-exempt mutual funds usually produce lower yields, you generally don't have to pay federal taxes on earnings from tax-exempt money market and bond funds. And you can save even more if you live in a state that offers similar exemptions.
But before you invest, ask yourself these two questions:
- 1. Am I investing outside of an IRA or another retirement plan?
You won't gain anything more by including a tax-exempt mutual fund in an already tax-advantaged account, like an IRA. Instead, you'd actually be giving up potential yields.
- 2. Am I in one of the higher tax brackets?
If you're not, tax-exempt funds probably aren't the right fit. You likely won't save enough in taxes to make up for the lower yields you typically get from a tax-exempt fund.
If you answered "yes" to both of these questions, a tax-exempt fund might be worth a look.
Make sure a tax-exempt fund is right for you
Your next step would be to determine your taxable-equivalent yield—the yield a tax-exempt fund would need to earn to meet or beat the after-tax yield of a comparable taxable fund.
Choose your tax-exempt funds
If you've determined you're a good candidate to start investing in tax-exempt funds, take a look at the funds you have to choose from.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
All investing is subject to risk, including the possible loss of the money you invest.
Bond funds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Vanguard provides services to the Vanguard funds and ETFs at cost.