Municipal bonds provide investors with tax-advantaged income that may be superior to other fixed income options. In particular, investors in the 25% or higher federal tax bracket may benefit the most from interest payments exempt from federal – and in some cases city – taxes. The downside is these bonds often are issued in high denominations, which can make it difficult for less-wealthy investors to build diversified portfolios.
In this article, we’ll take a look at target date muni bond funds and the advantages they offer to investors looking to build diversified portfolios with limited capital.
Target Date Funds 101
Municipal bond funds come in many different flavors. For example, some funds focus on holding only high-yield bonds, while others only hold revenue bonds. Target date muni bond funds represent a classification based on the maturity date of the underlying bonds.
Target date muni bond funds enable investors to realize the same benefits as holdings funds versus bonds – such as instant diversification and lesser capital requirements – as well as declining price volatility leading up to a certain point in time. For example, as an investor approaches retirement, these funds may be a great way to generate an income that becomes more reliable as outside sources of income are phased out (e.g. employment wages).
Sophisticated investors also may use target date muni bond funds to build a laddering strategy for ongoing income over time. Building bond ladders with individual securities can be time-consuming, whereas these bond funds may be used to invest in multiple funds across a range of different maturities. The idea is to reduce the impact on interest rates by diversifying maturity dates, while ensuring income continues past a certain point in time.
Popular Target Date Funds
There are many different target date municipal bond funds, including both closed-end funds that trade on exchanges, and mutual funds.
Fidelity offers a number of different mutual funds in the space, which primarily invest in investment-grade municipal bonds with similar maturity dates. These bonds are held to maturity, at which point, the funds liquidate the assets, which are distributed to shareholders.
Here are some of the most popular Fidelity funds:
- Fidelity Municipal Income 2017 Fund (FMIFX)
- Fidelity Municipal Income 2019 Fund (FMCFX)
- Fidelity Municipal Income 2021 Fund (FOCFX)
- Fidelity Municipal Income 2023 Fund (FCHPX)
Closed-end funds provide investors with a second option when investing in a basket of muni bonds with a similar maturity date.
BlackRock offers a number of different closed-end target date muni bond funds, which invests at least 80% of its assets in muni bonds that are investment grade at the time of purchase. Unlike mutual funds, it’s worth noting the closed-end funds may trade at a premium or discount to the actual market value of the bond portfolio.
Here are BlackRock’s closed-end fund options:
- Municipal 2018 Term Trust (BPK)
- Municipal 2020 Term Trust (BKK)
- Municipal Target Term Trust (2031) (BTT)
The Bottom Line
Municipal bonds provide a great way for investors to find tax-advantaged yield, but the high denominations and complexity keep many investors away. Using target date muni bond funds, investors can build exposure to a diverse portfolio of bonds while targeting a specific maturity date or building a ladder strategy to generate long-term income.
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