Vanguard Municipal Bond ETF: What You Need to Know

Investors considering an investment in a Vanguard municipal bond ETF are wise to weigh the potential benefits and risks of this type of fixed income exchange-traded fund. For example, many investors use municipal bond ETFs for certain tax advantages when held in a taxable brokerage account. But there are different types of municipal bond ETFs to consider, and these funds are not for every investor. 

Learn more about municipal bonds and see a list of Vanguard municipal bond ETFs. 

What Is a Vanguard Municipal Bond ETF? 

Vanguard offers two different municipal bond ETFs, which are exchange-traded funds consisting of different municipal bonds issued by various municipalities and government entities. This diversification helps spread risk across different issuers and geographic regions, reducing the impact of any single bond defaulting. Vanguard’s largest municipal bond ETF is the Vanguard Tax-Exempt ETF (VTEB). 

Municipal bonds, often referred to as "munis," are debt securities issued by state and local governments, as well as various government agencies and authorities. The primary purpose of issuing municipal bonds is to raise funds for public infrastructure projects, such as building schools, highways, water treatment facilities and other essential community projects. Interest income from municipal bonds is generally exempt from federal income taxes. 

Vanguard Municipal Bond ETF List 

There are two Vanguard municipal bond ETFs available to investors: 

• Vanguard Tax-Exempt ETF (VTEB): This ETF seeks to track the performance of the Bloomberg Barclays Municipal Bond Index. The index is composed of a broad range of investment grade municipal bonds, which are generally considered safer than lower-rated “junk” bonds, but they are not risk-free. Since investment grade bonds typically receive lower ratings than Treasuries, they may pay higher yields. VTEB has $28.07 billion in assets and an expense ratio of 0.05%. 
• Vanguard Short-Term Tax-Exempt Bond ETF (VTES): This fund tracks the S&P 0-7 Yr National AMT-Free Municipal Bond Index, which is a market-value-weighted index of investment grade tax-exempt municipal bonds with maturities between zero and seven years that are not subject to the alternative minimum tax (AMT). VTES has $182.06 million in assets and an expense ratio of 0.07%. 

Fund data as of August 8, 2023. 

Pros & Cons of Municipal Bond ETFs 

Investing in municipal bond ETFs offers various advantages, such as income generation and exemption from federal income tax. However, these funds also have some disadvantages, such as interest rate risk and credit risk.  

Here's an overview of the pros and cons of municipal bond ETFs: 

Pros 

• Income generation: Municipal bond ETFs provide a steady stream of income in the form of tax-exempt interest payments. This income can be particularly attractive to investors seeking reliable cash flow. 
• Tax advantages: Many municipal bonds offer tax advantages, such as exemption from federal income tax and, in some cases, state and local taxes. This can be especially beneficial for high-income investors looking to minimize their tax liabilities within a taxable brokerage account.  
• Diversification: Municipal bond ETFs hold a diversified portfolio of bonds from different issuers and regions. This diversification helps spread risk, reducing the impact of defaults by any single issuer. 
• Lower costs: ETFs generally have lower expense ratios compared to actively managed funds. This can translate into lower fees for investors over time. 
• Accessibility: Municipal bond ETFs provide retail investors with access to a market that might otherwise be harder to enter due to the minimum investment requirements of individual bonds. 
• Professional management: ETFs are managed by investment professionals who handle the selection, management and rebalancing of the bond portfolio, relieving investors of the need to make individual bond selections. 

Cons 

• Interest rate risk: Municipal bond prices can be sensitive to changes in interest rates. When interest rates rise, bond prices typically fall, potentially leading to losses for investors. 
• Credit risk: While municipal bonds are generally considered safer than corporate bonds, there is still a risk of default. Economic downturns or financial difficulties faced by municipalities can impact their ability to meet debt obligations. 
• Limited control: Investing in an ETF means entrusting portfolio management decisions to fund managers or remaining limited to securities within a benchmark index. This lack of control over individual bond selection may not align with the preferences of all investors. 
• Tax complexity: While municipal bond interest is often tax-exempt, there can be exceptions, and the tax treatment can vary depending on the investor's tax situation and the bonds held within the ETF. 

Bottom Line on Investing in a Vanguard Municipal Bond ETF 

Before you invest in a Vanguard municipal bond ETF, it’s wise to consider the potential benefits and drawbacks of this type of bond fund. For example, while municipal bond ETFs may provide tax-exempt income, they also can be sensitive to changes in interest rates and can be exposed to default risk. As with any investment, it's important for investors to carefully consider their investment goals, risk tolerance and time horizon before investing.