Taxable vs Tax-Free Mutual Funds

When investing in a mutual fund, tax is one of the major factors that you will have to consider. The tax that you pay as a result of investing in a mutual fund lowers the amount of money that you will be able to make overall. Here are a few things to consider about investing in taxable or tax-free mutual funds.

Tax-Free Mutual Funds

As it turns out, there is a type mutual fund that will prevent you from having to pay any taxes on your investment. This tax-free mutual fund focuses on municipal bonds and government investments. A municipal bond is a debt instrument that is issued by a municipality in order to raise money. These municipal bonds can be issued by city governments, school systems, airports and state governments. They represent a very low risk investment. When you invest in municipal bonds, there is no tax liability involved. Therefore, municipal bonds have always been a very attractive investment.

Although, the thought of investing in a municipal bond is attractive, it is not for everyone. It typically requires a large initial investment of at least $5000. This eliminates many investors as not everyone has that much capital to invest. The municipal bond mutual fund is much more accessible for the majority of investors. They utilize municipal bonds as the underlying asset of the fund and allow investors to purchase shares in the fund. Therefore, anyone that can buy into mutual fund can get involved in the municipal bond market.

Taxable Mutual Funds

Taxable mutual funds are the more traditional type of mutual fund that everyone is used to investing in. These types of mutual funds invest in stocks, corporate bonds, CDs, and treasury bonds. There are a number of different investments that could make up a mutual fund of this type. However, all of the other investments will incur some type of tax liability. This type of mutual fund can be purchased through any traditional broker and is widely available to the majority of investors in the market.

Taxable or Tax-Free

When choosing which type of mutual funds invest in there are a number of different factors that you will have to consider. For example, although it sounds great to invest in a tax-free bond, the return will usually not be as high. Municipal bonds represent a very low risk and therefore have a very low return to go with them.

Taxable mutual funds represent a much greater opportunity for growth. Since many of these mutual funds are made up of stocks there is no limit on the amount of growth that you could expect. Therefore as an investor, you have to decide whether you like safety and a low return or a little more risk and a potentially high return.

When deciding whether a tax-free mutual fund is worth it compared its average yield to the after-tax yield of other mutual funds. This will give you an apples to apples comparison.

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