Taxable-Equivalent Yield

We covered the basic tax benefit of municipal bonds in chapter 2. The key benefit from municipal bonds is that the interest received from municipal bonds is free from federal income taxes and can be free from state income taxes as well. With municipal bonds, everything comes down to taxes. If you are not going to benefit from the tax-exemption, you will earn more with taxable bonds. For instance, highly rated municipal bonds may actually yield less than even US treasury bonds since US treasuries are taxable. However, based on your tax-bracket, the tax-free municipal bond with a lower yield may offer you a higher after-tax return than the higher-yielding taxable US treasury bonds. You should know how to compare a tax-exempt (tax-free) bond with a taxable bond.

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