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Featuring

Chris Galeski, Wealth Advisor and Partner, Morton Wealth

Ian Rennick, Wealth Advisor, Morton Wealth

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Overview

Municipal bond yields are at their highest levels in 20 to 25 years, and the phrase “tax-free income” is getting a lot of attention from investors looking for safety and yield in a challenging rate environment. The case is easy to understand: if you live in California and own a California Muni bond, the interest you earn could be both federal and state tax-free.

But before you move into Munis based on that headline, there are a few things worth understanding first. In this episode of Financial Commute, Chris Galeski and Ian Rennick walk through the interest rate risk most investors are not thinking about, how to calculate the taxable equivalent yield, what you are giving up in exchange for the tax benefit, and why shorter-duration alternatives may offer comparable yields with meaningfully more flexibility.

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Key Takeaways

• Muni bond yields are near their highest levels in 20 to 25 years, which is why investors are interested. Interest rates rising from near zero to current levels has made the income on these bonds more attractive than they have been in a generation. A California Muni bond yielding 4 percent tax-free is the equivalent of roughly 8 percent taxable yield for investors in the highest combined federal and state tax bracket. However, the risks embedded in these yields make the total return less certain.

• The tax-free yield does not account for price risk, and 2026 has made that concrete. The iShares California Municipal Bond ETF was down approximately 4.12 percent year-to-date at the time of this recording. The Bloomberg Aggregate was down roughly 2.5 percent over the same period. Both fell because interest rates continued to rise. If you are earning 3.9 percent on the yield but the value of the fund is down 4 percent, your total return is effectively flat or negative. The yield headline and the total return are not the same number.

• To actually receive an attractive yield, you may need to hold the bond for ten years or longer. Most of the Muni bonds offering meaningful tax-free yields are out on the ten-year part of the curve, and some go as far as 20 or 30 years. If rates rise after you buy, the market value of your bond falls. You will get your principal back at maturity, but you are locked in for the duration. The flexibility you give up is real and has a cost that most headline comparisons ignore.

• There are risks beyond interest rate risk that deserve attention. California municipal bonds carry credit risk tied to the specific municipality or project being financed: a hospital, a school district, an airport, a water authority. Defaults in the Muni market are rare but not zero, and Chris is direct that he is not enthusiastic about lending to California's balance sheet for 20 years. Separately, purchasing power risk is real: $100,000 locked into a ten-year bond will be worth meaningfully less in real terms when it matures, especially in an inflationary environment.

Key Moments From This Episode

0:00 – Intro: municipal bond yields are at their highest level in 20 to 25 years
0:47 – Welcome: why muni bonds are suddenly back in the conversation
2:12 – The catch: duration risk and the inverse relationship between bonds and rates
3:36 – Taxable equivalent yield: how to measure a 4% tax-free return against other options
5:47 – The California muni bond ETF is down 4% this year despite the headline yield
6:32 – How to calculate taxable equivalent yield and what it actually means
8:00 – Private lending vs. munis: flexibility and short duration as an edge
9:57 – Lock-up periods matter: what you should expect in return for ten years of illiquidity
11:44 – Credit risk and California's balance sheet: why defaults are rare but real
13:29 – Morton's current stance: not no forever, just no right now
15:03 – When does a muni bond actually make sense for you?

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Questions This Episode Answers

Are municipal bonds a good investment right now?

Chris and Ian's answer is nuanced: not no, but not yet for most investors, and not without understanding what you are actually signing up for. Muni bond yields, as measured by the Bloomberg Municipal Bond Index, are at 20 to 25-year highs and are becoming more attractive as rates rise. But at current levels, the combination of interest rate sensitivity, long duration, purchasing power risk, and the availability of comparable taxable equivalent yields in shorter-duration alternatives means the risk-adjusted case for munis is not as clean as the tax-free headline suggests. If rates continue rising, the calculus may improve.

How does the municipal bond tax exemption work?

If you live in California and own a California municipal bond, the interest income you earn is exempt from both federal and California state income tax. This is the core of the appeal: for investors in the highest combined federal and state tax bracket, roughly 50 percent combined, a 4 percent tax-free yield is the equivalent of approximately 8 percent on a pre-tax basis. The exemption applies to interest income only, not to capital gains if you sell the bond before maturity.

What is the taxable equivalent yield on a municipal bond?

The calculation is: take the muni yield and divide it by one minus your combined tax rate. Example: a 4 percent muni yield divided by 0.50 (representing a 50 percent combined tax rate) equals an 8 percent taxable equivalent yield. This is the pre-tax return you would need to earn on a taxable investment to match the after-tax income of the muni. The number is meaningful, but it should be compared to actual alternatives rather than treated as a guaranteed outcome, particularly given that the total return on a muni fund also includes price changes, not just yield.

What is duration risk in a bond and why does it matter for munis?

Duration is a measure of how sensitive a bond's price is to changes in interest rates. A bond with a ten-year duration will fall roughly 10 percent in value for every 1 percent rise in interest rates. The muni bonds offering the most attractive tax-free yields today tend to be on the ten-year or longer part of the curve. If rates rise after you buy, the market value of your bond falls. You will receive your full principal back at maturity, but you may be locked in for ten or twenty years at a rate that is no longer competitive. The iShares California Municipal Bond ETF had a duration of approximately 9.2 years and was down about 4.12 percent year to date at the time of this recording.

What are the alternatives to muni bonds for tax-sensitive investors?

Chris and Ian discuss several alternatives worth comparing on a taxable equivalent basis. Ten-year US Treasuries at approximately 5.1 to 5.3 percent at the time of recording are exempt from California state tax, making them a meaningful comparison for California investors. Private real estate lending strategies can generally yield around 8 percent, and private diversified lending strategies can yield 9 to 11 percent, offering taxable equivalent yields that may be comparable to or better than a California muni on an after-tax basis, with the additional advantage of much shorter loan durations of one to two years, which provides flexibility to reprice if rates move higher.

What is credit risk in municipal bonds?

When you buy a municipal bond, you are lending money to a specific government entity or project, such as a city, a school district, a hospital, or an airport. Credit risk is the possibility that the borrower defaults and cannot repay you. Defaults in the muni market are historically rare, but they do occur. The quality of the issuer matters: a triple-A rated bond carries less credit risk than a single-A rated bond, but typically offers a lower yield in exchange. Chris is candid that he is not enthusiastic about lending to California's balance sheet for 20 years, which reflects a view about the state's long-term fiscal position rather than a claim about near-term default risk.

Why This Matters for California Investors in Higher Tax Brackets

The conversation around municipal bonds is directly relevant to any California investor who has seen a headline about tax-free income and is wondering whether it belongs in their portfolio. The case for munis has genuinely improved as rates have risen. The goal of this episode is not to dismiss them but to make sure the decision is based on the full picture, including duration, purchasing power risk, credit quality, and what alternatives are actually yielding today on a comparable after-tax basis.

• High-income California investors who have been told that a 4 percent tax-free muni yield is the equivalent of 8 percent and want to understand what that comparison assumes and what it leaves out
• Anyone who owns a California muni bond fund and is wondering why it has declined in value despite generating interest income

At Morton Wealth, we are watching municipal bonds closely and believe they will become a more important part of the investment discussion as rates continue to evolve. If you want to talk through whether munis make sense given your tax situation, time horizon, and the alternatives available in your portfolio, that is exactly the kind of analysis we can run for you.

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Watch relevant content:

How Inflation is Impacting Your Life & Investments

Build for Resilience, Not Prediction: The Healthy Skeptic Investment Approach

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Disclosures:

Information presented herein is for discussion and illustrative purposes only, does not represent any specific portfolio managed by Morton, and is not intended to constitute financial advice. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax, or legal advice. You should consult with your financial professional, accountant, or tax professional before implementing any transactions or strategies concerning your finances.

Index and Performance Information:

20-year performance of Muni Bond yields refers to performance of the Bloomberg Municipal Bond Index, which measures the performance of the U.S. dollar-denominated, long-term, tax-exempt investment-grade bond market.

The Bloomberg Aggregate refers to the Bloomberg US Aggregate Bond Index, which measures the performance of the U.S. investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market.

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