Calculating Your Tax-Equivalent Yield

When comparing interest rates on things like savings accounts, CDs, and bonds, it's a pretty simple process - the higher the interest rate, the higher the return. While that is simple enough, most of the time these types of investments are taxable. That means any interest you earn is taxed, which means your actual rate of return is lower than the interest rate.

But what about tax-exempt investments like municipal bonds? In cases like this, the interest that's generated may be exempt from federal, and in some cases, state income taxes. This means the interest you earn goes entirely into your pocket without having taxes eat away at the returns. Because of this difference, you can't simply compare interest rates between taxable and tax-exempt investments. Instead, you need to calculate your tax-equivalent yield to determine your real rate of return.