In partnership with

Dividend Download

Top dividend stocks & news

Unlocking Value in Municipal Bonds: Strategies for Tax-Free Yields and Duration Management

Municipal bonds are gaining traction as a compelling investment option, offering tax-free yields that are particularly attractive to high-income investors. These bonds are exempt from federal taxes and, for residents of the issuing state, often state taxes as well.

In high-tax states like New York (10.9% top income tax rate) and California (13.3%), this dual tax exemption can translate into significant savings, making munis a cornerstone for wealth preservation strategies.

Surge in Retail Investor Interest

The municipal bond market has seen robust retail investor participation in 2025. Vanguard’s Tax-Exempt Bond ETF (VTEB) has drawn $1.9 billion in inflows over the past month and more than $2.7 billion year-to-date.

With a 30-day SEC yield of 3.87% and a low expense ratio of 0.03%, this fund exemplifies the cost-effective appeal of munis for investors seeking tax-advantaged income streams.

Balancing Duration for Optimal Returns

While short-duration municipal bonds—less sensitive to interest rate changes—are popular for their stability in high-rate environments, they may limit upside potential.

Since bond prices and yields move inversely, short-duration bonds often miss out on price appreciation when rates fall. Conversely, longer-duration bonds offer greater sensitivity to rate changes, providing opportunities for capital gains when the Federal Reserve lowers rates.

Stephen McFee, a senior portfolio manager, warns against the "crowd mentality" pushing investors toward short-duration bonds to minimize duration risk. "The long-end of the market is where we see value now," he says, highlighting opportunities in longer-maturity bonds. McFee manages Vanguard’s Core Tax-Exempt Bond ETF (VCRM) with an average maturity of 14.4 years and a duration of 7.3 years, offering a 30-day SEC yield of 4.07% and an expense ratio of 0.12%.

Strategic Insights from Market Experts

Financial strategists are optimistic about a reacceleration in the municipal bond market rally in 2025. A June 2025 report suggests that market reactions to tariff-related headlines have stabilized, reducing the likelihood of sharp yield spikes seen earlier in the year.

Experts recommend overweighting single-A and triple-B municipal bonds and focusing on the intermediate yield curve (3- to 7-year maturities) to capture both yield and price appreciation while managing volatility.

Shannon Saccocia, chief investment officer at a wealth management firm, emphasizes the sweet spot of intermediate durations. "The 3- to 7-year range offers attractive pricing and yield without the extreme volatility of longer-duration bonds," she notes. Active managers are skillfully adjusting duration to balance risk and reward, ensuring portfolios are well-positioned for market shifts.

Customizing Duration for Portfolio Success

Investors building customized municipal bond portfolios can collaborate with financial advisors to determine an optimal average duration. Holding bonds to maturity can shield investors from price fluctuations, providing stability.

For those using ETFs or mutual funds, liquidity is a key advantage, though it comes with exposure to price volatility.

Blair duQuesnay, a certified financial planner, recommends blending short- and long-duration muni bond funds to achieve a target duration. "Start with the duration you're comfortable with, then adjust the fund ratio accordingly," she advises, stressing the need to understand each fund’s underlying strategy.

Top 5 Municipal Bond ETFs for 2025

Below is a list of the top five municipal bond ETFs for 2025, selected based on their tax-exempt yield, duration, expense ratio, and assets under management (AUM), with a brief description for each. Data is sourced from recent analyses and reflects values as of mid-2025 where available.

1. Vanguard Tax-Exempt Bond ETF (VTEB)
   VTEB tracks the S&P National AMT-Free Municipal Bond Index, offering a 30-day SEC yield of approximately 3.61% and an ultra-low expense ratio of 0.03%, making it a cost-effective choice for diversified, investment-grade municipal bond exposure. Its intermediate duration of around 5 years balances yield and interest rate sensitivity.

2. iShares National Muni Bond ETF (MUB)
   MUB, with over $32 billion in AUM, tracks an index of investment-grade U.S. municipal bonds, delivering a 30-day SEC yield of about 2.78% and a low expense ratio of 0.07%. Its broad portfolio of over 5,700 bonds and average duration of 5.4 years make it a core holding for tax-conscious investors.

3. Invesco National AMT-Free Municipal Bond ETF (PZA)
   PZA focuses on long-term, AMT-free municipal bonds with a 30-day SEC yield of around 4.1% and an expense ratio of 0.28%, appealing to investors seeking higher yields with longer durations (approximately 8 years). Its 3,600+ holdings provide robust diversification for those comfortable with greater interest rate risk.

4. Vanguard High-Yield Tax-Exempt Fund (VWAHX)
   VWAHX targets higher-yielding municipal bonds with a 30-day SEC yield of 4.18% and an expense ratio of 0.17%, offering a diversified portfolio of over 3,400 bonds with an average duration of about 7 years. It suits investors seeking enhanced tax-free income with moderate credit risk.

5. Xtrackers Municipal Infrastructure Revenue Bond ETF (RVNU)
   RVNU invests in revenue bonds for infrastructure projects, providing a 30-day SEC yield of 4.4% and a low expense ratio of 0.15%, with a longer duration of around 8 years. It’s an attractive option for investors seeking tax-efficient income and exposure to real assets.

Conclusion

Municipal bonds offer a powerful combination of tax-free income and potential capital appreciation, making them a vital tool for high-income investors. By strategically incorporating intermediate and longer-duration bonds and tailoring duration exposure with the help of advisors, investors can optimize their portfolios to capture value while navigating the complexities of a dynamic market. Whether through individual bonds or diversified funds, municipal bonds remain a cornerstone for tax-efficient wealth-building in 2025.

👩🏽‍⚖️ Legal Stuff
Nothing in this newsletter is financial advice. Always do your own research and think for yourself.