Some of the advantages of muni bonds include:

• Municipal bond interest income is generally exempt from federal, and sometimes state and local, income taxes. Your marginal tax bracket is a major factor when deciding whether to invest in municipal bonds. Thus, you should compare a muni bond's yield to the after-tax yield of a comparable taxable bond. To do that, you need to calculate the muni bond's taxable equivalent yield. If you're not investing in a municipal bond issued in your resident state, the calculation is as follows: the taxable equivalent yield equals the tax-exempt interest rate divided by one minus your marginal tax bracket. For example, if you are considering a municipal bond with a yield of 5.7% and you're in the 25% tax bracket, the taxable equivalent yield is 7.6% (5.7% divided by 1 - 25%).

• A wide variety of bond choices exist. With over a million municipal bond issues outstanding, you can find bonds with all kinds of different characteristics.

• Muni bonds typically have high credit ratings. Municipal bond defaults are rare, but they do occur. Make sure to review the credit quality carefully before investing. About half of all muni bonds are insured, but with downgrades to the credit ratings of many of the bond insurers, it is important to look at the underlying rating of the bond issue itself. You may want to stick with investment-grade ratings, which is an indication that the issuer is considered financially stable and unlikely to default.

Some disadvantages of municipal bonds include:

• Muni bonds are not appropriate for all types of portfolios. Munis should not be considered for individual retirement accounts (IRAs), 401(k) plans, or other tax-advantaged plans. Since municipal bond interest is already exempt from federal income taxes, you gain no further benefit by placing the bond inside a tax-advantaged vehicle. In fact, the interest income will ultimately be subject to ordinary income taxes when withdrawn.

• Municipal bonds are callable. Most muni bond issues have call provisions, which allow the issuer to redeem the bonds before maturity. The exact provisions, however, can differ significantly between bonds, so carefully review the provisions before purchasing a bond. While you can't prevent an issuer from exercising a call provision, you can purchase bonds with call provisions most favorable to you.

• Muni bonds are still subject to some taxes. While interest income is typically exempt from federal income taxes, selling a bond before maturity for a profit will result in a taxable gain. Also, some bonds pay interest income subject to the alternative minimum tax (AMT). State and local taxes must also be considered if the bond is not issued in the state of your residence.