Municipal Bonds as an Investment Choice: How Tax Status Changes the AGG vs. MUB Equation

When evaluating whether municipal bonds represent a sound investment, the answer depends heavily on your specific tax situation rather than the bonds themselves. The iShares National Muni Bond ETF (MUB) and the iShares Core US Aggregate Bond ETF (AGG) demonstrate this principle perfectly. These two funds represent fundamentally different approaches to fixed income investing, with municipal bonds offering distinct tax advantages that can meaningfully impact after-tax returns for higher-earning investors.

AGG provides exposure to the entire U.S. investment-grade bond universe, while MUB focuses exclusively on municipal bonds issued by state and local governments. Both funds maintain remarkably low operating costs and strong liquidity, making them accessible options for different investor profiles. Understanding their differences requires looking beyond headline yields to examine how your tax bracket transforms the comparative value of each fund.

The Cost-Efficiency Comparison Between AGG and MUB

From a pure fee perspective, AGG delivers a marginal advantage. The fund charges just 0.03% annually compared to MUB’s 0.05%, though the difference amounts to only $3 per $10,000 invested annually. The real distinction emerges in yield and fund size rather than expense ratios.

AGG currently offers a 3.9% dividend yield on its $136.5 billion in assets under management, while MUB provides a 3.1% yield supported by $42.0 billion in assets. At first glance, AGG’s higher yield appears superior. However, this comparison requires an important asterisk: AGG’s yield is fully taxable as ordinary income at federal and state levels, whereas municipal bond income in MUB enjoys federal tax exemption—and often state tax exemption for residents in the issuing state.

Recent performance data (as of January 2026) shows AGG generating a 1-year return of 4.4% compared to MUB’s 1.9% total return. The size difference between the two funds also matters for practical investing; AGG’s substantially larger asset base ensures tighter bid-ask spreads and easier trade execution, providing superior liquidity for investors who need to adjust positions quickly.

Performance Metrics and Five-Year Risk Assessment

The risk profiles of these funds diverge in meaningful ways when examined over longer periods. AGG experienced a more severe peak-to-trough decline of -17.83% over the past five years, while MUB’s maximum drawdown reached -11.88%. This difference reflects AGG’s broader exposure to interest-rate-sensitive securities, particularly mortgage-backed bonds, which amplified price declines during the 2022 rate-hiking cycle.

Over a five-year period, a $1,000 investment in AGG would have declined to approximately $857, while the same amount in MUB would have grown to $922. This comparison illustrates that despite AGG’s higher stated yield and stronger recent performance, the longer-term risk-adjusted returns favor MUB’s more concentrated municipal bond focus. The relationship between bond prices and interest rates means that broader bond portfolios experience amplified volatility during periods of rising rates—a phenomenon that directly impacts five-year drawdown comparisons.

Understanding Portfolio Composition: Breadth vs. Specialization

AGG holds 13,015 individual positions spread across the entire U.S. investment-grade bond market: Treasury securities, corporate debt, and mortgage-backed securities. This broad diversification means AGG investors gain exposure to multiple bond sectors in a single holding. The fund targets the broadest possible representation of the domestic bond market, making it an appropriate core holding for investors seeking comprehensive fixed income diversification.

MUB takes the opposite approach, concentrating on 6,098 municipal bond positions exclusively. These bonds finance infrastructure projects, school systems, hospitals, and other public services throughout the United States. The narrower focus means MUB investors accept less sector diversification but gain concentrated exposure to a specific bond category with inherent tax advantages.

Both funds maintain completely liquid portfolios currently positioned at 100% in cash and equivalents, ensuring both can meet redemption requests without portfolio strain.

Which Fund Suits Your Tax Situation: A Decision Framework

The investment case for municipal bonds depends critically on your effective tax rate. Investors in the 12% to 22% federal tax brackets, or those utilizing tax-deferred retirement accounts like 401(k)s and IRAs, should generally prioritize AGG. Its higher yield and broader diversification deliver superior after-tax returns in lower-tax situations, and the tax-deferred status of retirement accounts means municipal bond tax advantages provide no additional benefit.

For high earners in the 32% federal tax bracket or above using taxable accounts, municipal bonds become substantially more compelling. MUB’s 3.1% tax-exempt yield translates to an equivalent taxable yield of approximately 4.6% when calculated at the 32% federal rate—exceeding AGG’s 3.9% fully taxable yield. When combined with state tax exemptions available to residents of issuing states, the after-tax advantage becomes even more pronounced, potentially reaching 5.5% or higher in high-tax states like California or New York.

The decision also involves considering your investment timeline. AGG’s superior liquidity and five-year risk profile make it more suitable for investors who may need to adjust allocations within a shorter timeframe. MUB’s concentration risk requires a longer holding period and conviction in the municipal bond market, though this is mitigated by the strong credit quality of investment-grade municipal bonds.

Bond ETFs function as stability anchors within most portfolios, generating steady income while equity positions fluctuate. Municipal bonds specifically serve as a tool for high-income earners to optimize after-tax returns without sacrificing credit quality or liquidity. Whether municipal bonds represent a good investment ultimately depends not on the bonds themselves but on aligning fund selection with your tax bracket, time horizon, and diversification requirements. Both AGG and MUB serve legitimate purposes within different investor profiles—the key lies in matching the right fund to your specific financial situation.