Municipal or "muni" bonds are issued by states, counties, cities, colleges, school districts and other municipal agencies to finance public projects. In most cases, their interest is exempt from federal taxes. If you buy bonds issued in the state in which you live, the interest is usually exempt from state taxes as well.

Most full-service and discount brokers sell muni bonds. Some issuers sell them directly to investors. You can also buy them by purchasing shares in a municipal bond fund, which offers diversification and professional management.

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