Dear Dr. Don,
I have been investing in CDs for a few years now. I am careful to spread out my money into different banks so that I don't go over the limits of the Federal Deposit Insurance Corp.
Recently, I read that I may benefit by investing also in municipal bonds or other tax-free bonds. I am in the 30 percent tax bracket.
I have a CD for $40,000 that matures in 30 days. I am interested in renewing this CD for a couple of years, but am wondering if municipal bonds be a better choice? If so, what type of bonds do you suggest? Or should I just stick with the CDs?
-- Pam Potential
It's easy enough to compare rates between the CDs and the municipal securities, or munis, by comparing the tax equivalent yields on the two investments. Bankrate's "Tax equivalent yield calculator" will do the math for you.
To use the calendar, you'll need to know the interest rate on the municipal security, your estimated taxable income and your combined state and local income tax rates (if the municipal security you're considering is exempt from your state and local income taxes.)
I can't make a blanket recommendation when it comes to municipal securities versus CDs. Each municipal security has credit characteristics unique to its taxing authority and how the security is structured. Meanwhile, an FDIC-insured deposit in a CD carries the full faith and credit pledge of the U.S. government.
Bankrate's "Compare money market mutual fund rates" lets you check out the short-term yields on tax exempt (muni) money market funds. Bankrate also lets you shop CD yields -- you can look for the best deals in your local market, or search for the highest yield nationwide.
Munis aren't a great place for do-it-yourself investors. There are plenty of opportunities in today's interest rate environment for municipal investors but you should get professional advice before investing. I recommend talking to a fee-based financial planner.
The National Association of Personal Financial Advisors, or NAPFA, can help you find a fee-based planner in your area. Bankrate also can help you find a Certified Financial Planner.
You can also consider investing in municipal bond mutual funds. You don't have the degree of control you would have in buying individual municipal securities, but you gain professional money management and diversification of your holdings.
Many mutual fund firms offer municipal funds specific to your state of residence that may keep interest income free of state income taxes.