Q&A: Government or Tax-Free

Q:

You frequently mention putting the bond fraction of a diversified portfolio in short and intermediate-term bond funds. My question is: if one needs to keep some of those bonds in a taxable account, are tax-free (municipal) bond funds a reasonable alternative to treasuries?

A:

Municipal bond funds can be a reasonable alternative to taxable government bond funds for those who are actually in the highest tax brackets. If the desire is merely avoiding taxes, on principle, then stick with short and intermediate government bond funds.

Tax-free bonds are inherently riskier than US government paper, and they are more lightly trading, making their prices more volatile. So, stick with investment-grade, short to intermediate term muni bond funds with the lowest possible fees.