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A muni ETF or muni bond ETF, is a specific kind of financial product based on municipal bonds. Understanding the muni ETF is a two-part process. There’s the issue of how exchange traded funds (ETFs) are set up, as well as questions about the underlying holdings of the municipal bonds themselves.
Somewhat like a mutual fund, an ETF is a diversified fund. One of the distinguishing characteristics of an ETF is that it can be easily bought and sold over an exchange. Various companies offer exchange traded funds with a wide diversity of underlying holdings including currencies, commodities, stocks, and bonds.
Municipal bonds comprise the holdings of a muni ETF. There are two principal kinds of bonds in most financial systems: the municipal bonds and the corporate bonds. Both of these are holdings that are based on existing debt. The corporate bonds are based on the debts of corporations, where the municipal bonds are based on the debts of national, state, regional or local municipalities.
One of the draws of muni ETFs are that these “pre-made” products make it easy for the individual investor to hold an interest in various municipal bonds. Classically, these bonds have been great gainers for a variety of single investors who profited from investing in municipal debt. Today, there are some risks that experts are looking at that are commonly associated with municipal bonds. Specifically, in any fund or product that is based on bonds, there is a major risk based on the potential inability of the bond issuer to repay its debt.
In addition to the risks of nonpayment that go along with any bond funds, experts also warn investors and clients to stay away from unintentional redundant holdings, such as holding a portion of a company’s stock directly and also holding some 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 doesn’t look carefully at what the fund involves, he or she may not really know the details about his or her holdings.
In general, many experts are enthusiastic about the potential of muni ETF selections, and other municipal bond funds to make a profit over time. The key is to thoroughly research the bond issuers, and to be confident about that party’s ability to repay any existing debt. It’s also a good idea to research a variety of alternatives to assess just how risky a muni ETF may be. Many times, greater yield goes along 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.