Originally Posted by statsman
Is this because all income earned in an IRA is taxable, and that the taxable bond funds have a higher yield than the tax-exempt bond funds?
What if the money to be invested is sitting outside of a tax deferred account, like in a MM? I live in California, and both my wife and I work. We are looking at the CA tax-exempt bond funds vs. the taxable bond funds and trying to determine the trade-offs.
Start by calculating the equivalent taxable yield of a muni fund/bond with the equation given below and comparing it to the yield of the taxable funds.
If you're in a high tax bracket it usually makes sense to have muni bonds in a taxable account. If you're in a low tax brackets it usually makes sense to have taxable bonds in your taxable accounts. You should never have muni bonds/funds in a tax deferred account. Some think that you should have all of your bond exposure in tax deferred accounts so that you can take advantage of the higher yields of taxable bonds.
Muni bonds seem to be particularly attractive now because of the things going on in the credit market. Others that follow those markets may have comments?
Equivalent taxable yield = Yield of Muni Fund / (1 - your incremental tax rate expressed as fraction)
Vanguard has some pretty good CA tax exempt funds. I own both their CA money market and intermediate term funds.