Bond Rate Apples to Apples

Closeup of rolled United States five dollar bills tightened with red rubber bandYou can be forgiven for scratching your head at the current bond market, and one of the more perplexing aspects of it is the yield curve in the municipal bond environment. According to Bloomberg, the current average yield on muni bonds with a 1-year maturity is 2.66%. But let’s say you want to take more risk and go out five years; what is your reward for taking that extra risk? It’s actually negative; the average yield on 5-year bonds is currently 2.19%.

Of course, ‘average’ covers a lot of territory, from low-rated to high-rated, across different states and municipalities, covering a lot of different projects and funds. And the other thing you have to consider is the tax-equivalent yield of the muni coupon vs. the more commonly-quoted corporate bonds.

The what? Most municipal bonds are not taxed at the federal level, and if you happen to live in the state where they are issued, you also escape state taxation on their yields. So you have to factor in the fact that these yields are tax-free in order to compare apples (the tax-equivalent yield of the muni) to apples (the after-tax yield of the corporate bond).

Fortunately, there’s an easy calculation engine on the web (go here: Tax-Equivalent Yield Calculator), where you enter the rate of return of the muni bond you’re considering, and your own marginal tax rate, and it will give you the yield that you can compare with a taxable bond. Let’s say you’re in the 32% tax bracket (for joint filers earning more than $340,100) and you buy that ‘average’ one-year muni bond at a 2.66% yield. Plug in the numbers and you see that the corporate bond would need to yield 3.91% to provide a superior after-tax return. But if you’re in the 22% marginal tax bracket (AGI above $83,550), then the corporate bond would only need to yield 3.41% to offer the same after-tax return.

Municipal bonds are not appropriate investments in a traditional or Roth IRA, where bond yields are not taxed each year regardless of what kind of instrument you purchased. But for taxable accounts, this calculation should be a consideration when you’re investing in fixed-income individual bonds, funds or ETFs.



Written by: Danielle P. Barger of Barger & Battiest Law, APC. Danielle P. Barger is a Certified Specialist in Estate Planning Trust and Probate Law (State Bar of California Board of Legal Specialization). For additional information on estate planning, please visit her website at or call (858) 886-7000.