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Muni closed-end funds are mutual funds containing only municipal bonds, traded like stocks, with tax benefits for high earners. They offer diversity and protection from bankruptcy. Share prices depend on bond value and supply and demand.
Muni closed-end funds are a type of mutual fund that only contains municipal bonds. Mutual funds are generally bought and sold once a day after the stock market closes, while closed-end muni funds trade like stocks, meaning shares can be bought and sold throughout the day. People with high tax brackets often buy these types of funds because these investments pay dividends that are generally not taxed.
Municipalities sell two types of bonds: general obligation bonds and revenue bonds. Government entities sell general obligation bonds to raise money for short-term expenses like payroll and law enforcement. Bondholders lend money to the government for a period of time, and the government pays the bondholders interest payments derived from taxes. Revenue bonds are sold to raise money for revenue-generating municipal projects, such as airports. Bondholders receive interest payments based on the income generated from the completed project.
In the United States, the federal government does not assess taxes on interest payments from municipal bonds or dividends paid by municipal closed-end funds. Investors who buy bonds issued by a local government, based in the state where they live, do not have to pay state income taxes on the interest. People with high tax burdens often buy municipal bonds or municipal closed-end funds to take advantage of these tax breaks.
Muni’s closed-end funds begin with an initial public offering during which shares are sold to investors and funds are raised to purchase the underlying municipal bonds. Investors cannot buy the fund after the initial public offering, but can buy shares on the secondary market from existing shareholders. Muni funds pay a regular dividend that is based on the interest payments the fund company receives on the bonds it owns.
The main benefit that closed-end municipal funds have over individual municipal bonds is diversity. If a project financed with revenue bonds or a municipal government goes bankrupt, the bondholders can lose all their money. Muni’s closed-end funds contain thousands of bonds issued by different government entities, so if a municipal government files for bankruptcy, it affects the fund but does not cause shareholders to lose their entire investment.
Municipal closed-end fund share prices are based in part on the value of the underlying bonds, but are also dependent on supply and demand. Shareholders have to negotiate a sale price when selling shares. During a booming market, a shareholder can sell a stock at a premium while during a market downturn, shareholders often have to sell a share for less than its true value.
Smart Asset.
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