Muni ETFs are financial products based on municipal bonds that can be easily bought and sold through an exchange. They offer diversification, but investors must be aware of default risks and unintentional redundant holdings. Thorough research is necessary to assess risk and make informed decisions.
A muni ETF or municipal bond ETF is a specific type of financial product based on municipal bonds. Understanding the muni ETF is a two-part process. There’s the question of how exchange-traded funds (ETFs) are set up, as well as questions about the underlying holdings of municipal bonds.
Somewhat similar to a mutual fund, an ETF is a diversified fund. One of the distinguishing features of an ETF is that it can be easily bought and sold through an exchange. Several companies offer exchange-traded funds with a wide variety of underlying holdings, including currencies, commodities, stocks, and bonds.
Municipal bonds comprise holdings of a municipal ETF. There are two main types of bonds in most financial systems: municipal bonds and corporate bonds. Both are holdings that are based on existing debt. Corporate bonds are based on the debts of corporations, where as municipal bonds are based on the debts of national, state, regional or local municipalities.
One of the attractions of muni ETFs is that these “off-the-shelf” products make it easy for the individual investor to hold an interest in multiple muni bonds. Classically, these bonds have been big winners for a variety of individual investors who benefited from investing in municipal debt. Today, there are some risks that experts look at that are commonly associated with municipal bonds. Specifically, in any fund or product that is based on bonds, there is significant risk based on the potential inability of the bond issuer to service its debt.
In addition to the default risks that accompany bond funds, experts also caution investors and clients to steer clear of unintentional redundant holdings, such as holding a portion of a company’s stock outright and also holding part of that entity’s debt in a muni ETF or other similar product. One of the key benefits of the ETF is that it provides diversification; The other side of the coin is that if the individual investor does not carefully consider what the fund entails, he may not really know the details of his holdings.
In general, many experts are excited about the potential for muni ETF picks and other municipal bond funds to turn a profit over time. The key is to thoroughly research bond issuers and be confident in that party’s ability to pay any existing debt. It’s also a good idea to research a variety of alternatives to assess how risky a municipal ETF may be. Many times, higher yield comes with more risk, but that’s not always the case, and investors who do their homework can make more deliberate and informed decisions about which ETFs and other funds to participate in.
Smart Asset.
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