Whether it's the expected refund from the Internal Revenue Service or the batch of canceled checks you mailed with your Form 1040, any reminder of the taxes you paid on 1991 income is bound to smart.
It also may cause you to wonder whether -- and how -- you could pay less on comparable income this year, thereby netting more money.
Although about one-third of the year is already behind us, you still may be able to hold down your taxable 1992 income -- and, thus, your taxes -- by switching from taxable income-producing investments to tax-exempt municipal bond funds. (Let's assume this wouldn't result in offsetting costs, such as taxes on capital gains that you may realize when selling these investments.)
How can you know whether this could work? By performing a simple calculation.
Assume a municipal bond fund pays a dividend at an annual rate of 6.5 percent and you're in the 28 percent federal income tax bracket. Divide 6.5 by 1 minus .28, or .72, and get 9.03 -- the tax-equivalent yield. Unless a taxable investment yields more than 9.03 percent -- 6.5 percent after taxes -- a tax-exempt 6.5 percent would give you more cash.
If you're in the 31 percent bracket, a tax-exempt yield of 6.5 percent would be even more attractive; it's the equivalent of a taxable 9.42 percent. (To keep things simple, these calculations disregard state and local income taxes.)
Whatever your bracket, if investing in a tax-exempt bond fund could be advantageous and if you can accept the volatility that such funds might involve, which type would be worth considering?
A high-yield municipal bond fund, maybe. As classified by Lipper Analytical Services, there are 26. Like the more than 120 general municipal bond funds, they invest in long-term state and local government issues and, therefore, involve greater risk than short- or intermediate-term funds do that prices will fall when interest rates rise. They also have higher yields.
Unlike general funds, which primarily invest in investment-grade bonds, high-yield funds may invest heavily in lower-grade securities issued by governmental units whose ability to pay interest and repay principal when scheduled may be questioned.
Given similar maturities, the more credit risk inherent in a fund, the higher its yield.
Not all high-yield funds are equally risky. Some are concentrated in bond issues regarded as investment grade -- Aaa, Aa, A, and Baa, according to Moody's -- but simply may have most of their assets in the two lower grades, A and Baa.
Others invest, in varying proportions, in issues rated below investment grade, known as junk bonds.
Some funds also have large holdings of unrated bonds, usually sold in small volumes by governmental units that don't want to incur the costs of obtaining ratings or that don't have to because funds buy all or most of their issues. The credit quality of these bonds may be comparable to investment-grade securities in the eyes of funds' credit analysts, or lower.
What you have to decide, in studying the differences among these funds, is how much income you want and how much risk you feel comfortable in accepting to get it.
Franklin High Yield Tax-Free Income Fund has about 52 percent of its assets in investment-grade bonds. The rest is split about equally between junk and unrated issues whose credit quality Franklin judges to be comparable to Baa.
"It's helpful to have the liquidity of investment-grade bonds in a down market," says Ronald Blake, portfolio manager, mindful of the difficulty he could have in selling unrated paper.
Fidelity Aggressive Tax-Free Portfolio is about 35 percent in non-investment-grade issues, down from 50 percent in 1986-87, and Anne Punzak, portfolio manager, plans to maintain this level.
T. Rowe Price Tax-Free High Yield Fund is about 25 percent in junk bonds, down from a peak of about 40 percent, according to C. Stephen Wolfe II, associate portfolio manager.
On the other hand, Ian A. MacKinnon, senior vice president in charge of Vanguard's fixed income group, has 93 percent of his High- Yield Portfolio's assets in investment-grade securities.
Mr. MacKinnon says he isn't buying more junk bonds because of "the meager incremental returns for going down in quality."
As for unrated issues, he is concerned about their liquidity -- about his ability to sell them if he wanted or had to. "Buying them is more of a marriage than a date," Mr. MacKinnon says.
Kurt Larson, whose $5.4 billion IDS High Yield Tax-Exempt Fund is the largest, also has more than 90 percent in investment grades. "We like Baa's and A's, where we can get a good yield," he says. Mr. Larson favors revenue bonds issued by providers of essential services -- electricity, water, and sewer facilities -- instead of general-obligation bonds dependent on tax revenues.
Mr. Blake finds especially attractive certain "special tax deals" bonds to finance the infrastructure of new residential or industrial developments, which are secured by the communities' taxes.
Price has about 30 percent in hospital issues. It focuses, Mr. Wolfe says, on hospitals that are the dominant, if not the only, providers of health services for rural or semirural areas around