Rising Rates, Tax-Free Income: Why American Century's TAXF is a Smart Play

In a year marked by Federal Reserve caution and economic uncertainty, investors seeking reliable, tax-efficient income face a unique challenge. The American Century Diversified Municipal Bond ETF (TAXF) has quietly positioned itself as a standout solution. With its May 2025 distribution rising to $0.1636 per share—a 16% jump from April's $0.1403—and an annualized yield of 3.57%, TAXF offers a compelling blend of income consistency and tax advantages in an environment where rising rates have investors on edge.

The Tax-Free Advantage in a High-Rate World

While the Federal Reserve's federal funds rate remains anchored at 4.25%-4.50% (as of June 2025), with only two potential cuts forecast this year, high-income earners are under pressure to maximize tax-free income. Municipal bonds, exempt from federal income tax, shine here. For investors in the top tax bracket, a taxable bond yielding 4.5% would deliver just 2.8% after taxes—far less than TAXF's 3.57% yield.

This comparison highlights TAXF's edge: even as Treasury yields have fluctuated, its tax-free status ensures a superior net return for eligible investors.

Navigating Rate Risks with Strategy and Structure

TAXF's success stems from its disciplined approach. Tracking the S&P National AMT-Free Municipal Bond Index, it avoids bonds from U.S. territories and focuses on investment-grade issuers. Its portfolio's weighted average maturity of 7-10 years balances income generation with liquidity, reducing vulnerability to sudden rate hikes.

While rising rates typically pressure bond prices, the fund's intermediate maturity and emphasis on credit quality mitigate this risk. The expense ratio of just 0.29%—among the lowest in its category—further amplifies returns.

The Fed's "Wait-and-See" Creates an Opportunity

The Federal Reserve's current stance—holding rates steady while monitoring inflation and growth—creates a favorable backdrop. With core PCE inflation projected at 2.8% in 2025, below the Fed's 2% target, the path to rate cuts is still viable. A potential June meeting decision could stabilize rates, reducing volatility.

For TAXF, this environment is ideal. A Fed pause or eventual cut would ease bond market pressures, while the fund's tax-exempt status remains irreplaceable for high-income investors.

Historical data reinforces this thesis: between 2020 and 2025, this strategy delivered an average return of 0.8% per holding period, with a 60% success rate (positive returns). While drawdowns occasionally reached -1.2%, the strategy's consistency and low volatility align with TAXF's risk profile. These results underscore its resilience in rate-sensitive environments, making it a pragmatic choice as the June FOMC meeting approaches.

Risks? Yes, but Manageable

No investment is without risk. TAXF's non-transparent structure, which uses a proxy portfolio for holdings, could lead to wider bid-ask spreads during volatility. Credit risk is another concern, though the fund's focus on investment-grade bonds and state/local issuers (which dominate the portfolio) mitigates this.

Liquidity risks are also tempered by its intermediate maturity profile, which allows the fund to adjust holdings as rates evolve.

The Bottom Line: Act Now—Before the Window Narrows

TAXF isn't just a defensive play; it's a strategic move. With its yield, tax efficiency, and structured risk management, it offers a rare combination of safety and income in an uncertain market. Investors should act swiftly to lock in this tax-free yield before potential Fed rate cuts or inflation shifts alter the landscape.

As the June FOMC meeting approaches, now is the time to position for both income and tax savings. TAXF isn't just keeping pace—it's leading the way.

This analysis is for informational purposes only. Consult a financial advisor before making investment decisions.