CAN YOU BENEFIT FROM MUNICIPAL BONDS? (FINANCIAL FOCUS)

This "Financial Focus" column is prepared by Edward Jones Investments, headquartered in St. Louis. Jones includes branches throughout the nation, including Cape Girardeau and Jackson.

These days, it seems as if everyone is following the stock market. With the spectacular runup in stock prices over the past few years, many investors have become focused on growth. Is their money growing? How fast? How much?

The pursuit of growth can overshadow the fact that many people invest for another reason: income. Furthermore, even those investors who seek growth can achieve diversification through income-producing vehicles. And one of the most popular ways to achieve income is through bonds.

Obviously, if you're investing for income, you want to earn as much as you can, so you would look for the highest-yielding bond possible, right? Not necessarily. It's not just what you earn that's important -- it's also what you can keep.

Typically, the highest-yielding bonds are those issued by a corporation, but you won't get to keep all the income you earn from corporate bonds, because these bonds are fully taxable. Therefore, your actual return will be less than the bond's stated interest rate. How much less depends on your individual tax bracket.

Municipal bonds are a popular alternative to taxable bonds. When you invest in municipal bonds, your income is exempt from federal income taxes. And, if you buy bonds issued by the state or municipality where you live, your earnings also may be exempt from state and local taxes.

Many investors in high tax brackets have long used municipal bonds to provide tax relief. However, even if you're in the 28 percent federal tax bracket, you may still come out ahead with a municipal bond vs. a higher-yielding, taxable corporate bond.

How can you know for sure? The answer lies in a term called the taxable equivalent yield. This figure essentially describes how much yield you would have to earn on a taxable investment, such as a corporate bond, to match the tax-free return offered on a municipal bond.

It's easy to calculate the taxable equivalent yield: Just divide the tax-free yield by one minus your tax rate. For example, if you're in the 28 percent bracket and you're considering a municipal bond that earns 5.5 percent, you would have to find a taxable bond that pays 7.64 percent to earn the same amount of income. If the municipal bond is also exempt from state income taxes, and your state income tax rate is 5 percent, then you would need an 8.21 percent taxable yield to match the earnings of the tax-free municipal.

When you compare taxable bonds with tax-free issues, make sure the maturity is the same for both types of bonds. Also, compare only those bonds with the same credit quality -- the rating the bond receives from an independent rating agency.

If you determine a municipal bond is right for you, you'll be doing more than just helping your own bottom line. You also may be providing vital funding to a specific project or infrastructure improvement that you'd like to support, such as a school, library or hospital. That's a true "win-win" situation.

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.