Why You Should Have Municipal Bonds in Your Taxable Account

Long ago, there was a time before the internet. Back then, savings bonds used to be made out of paper and the only place that you could get them was at a bank. In those days, the banks controlled all the investing for a poor person, because brokerages didn’t want to deal with poor people until they were at a certain investment threshold and were willing to pay an investment advisor. As the internet started to become more of a thing, banks still controlled all investments but it became more possible to buy stocks as long as a person was willing to pay transaction fees. Back in those days you could buy municipal bonds through an online clearing house, but they encouraged you to buy the whole bond, which are usually sold in five thousand dollar increments. Of course, I was even poorer back then than now, so I never could invest in the municipal bond market.

Fast forward to now. These days there are a number of brokerages that offer free accounts with no transaction fees for trades in equities. Another thing nowadays is that there exists many municipal bond exchange traded funds, also called ETFs.

Why would you want to own municipal bonds? Here’s the thing. The bonds usually pay better than treasury bonds and are just as safe, and also you don’t have to pay federal or state taxes on the money you make from the bonds. That being said, there are a lot of other investments available where a person can get a better return.

Why should this super-safe but relatively lower-yielding investment class be in your taxable account? Because you will not pay any income taxes on the money you earn, not capital gains either. No more worrying about if the investment has qualified or unqualified taxes. Indeed, the relative lack of taxes raises your actual yield higher, about 25% higher. This kind of savings means that if you are trying to maximize your returns on all of your investments, you should put government and municipal bonds in your taxable account and REITs in your Roth.

Specifically, the ETF that I am most interested in is called SCMB, Schwab’s newly created municipal bond ETF. The expense ratio is a measly 0.03%, and the dividend yield as of the end of November 2023 is 2.91%. Not bad for an extremely safe monthly paying ETF. The relative tax savings of the municipal bonds make this an investment equal to a regular stock or ETF with a dividend yield of 3.6%.

There are a few other municipal bond ETFs that I am looking at called, specifically JMHI, HYD and MMHYX. Both have higher expense ratios, but they also have higher dividend yields. They both pay monthly dividends.

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