Investing in tax-exempt mutual funds may be one approach. “With rates so low, this is a frustrating time for investors who need income,” says Neil Langberg, an American Funds fixed-income portfolio manager. “Fortunately, because the municipal bond market is vast and diverse, compelling yield opportunities can be found in a variety of places.”
It’s important to remember that different types of municipal bonds react differently to changing circumstances, so diversifying among market sectors can help income-focused investors weather a variety of economic and market conditions. Diversification doesn’t eliminate risk, but it can help limit the impact of risks faced by individual bond issuers. Some tax-exempt bond funds hold as many as 2,000 different securities with differing maturities and credit structures, so investors are less likely to feel the effect of a negative event affecting a single issuer like a municipal bankruptcy.
Bonds also carry risk in that, if monetary policy tightens, interest rates will rise and bond investors could be exposed to principal loss. Ask your adviser if tax-exempt bond funds are an option you should consider.