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Municipal bond funds
Municipal bond funds | Rido/Shutterstock.com

Municipal bond funds

How they're valued: Municipal bond funds invest in a number of different municipal bonds, or munis, issued by state and local governments. Earned interest generally is free of federal income taxes and also may be exempt from state and local taxes.

Risks: Individual bonds carry the risk of default, meaning the issuer becomes unable to make further income or principal payments. Cities and states don't go bankrupt often, but it can happen. Bonds also may be callable, meaning the issuer returns principal and retires the bond before the bond's maturity date. This results in a loss of future interest payments to the investor. Fortunately, bond funds spread out potential default and prepayment risks by owning a large number of bonds, thus cushioning the blow of negative surprises from a small part of the portfolio.

Liquidity: You can buy or sell your fund shares every business day. In addition, you usually can reinvest income dividends and make additional investments at any time.

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