Many people do not invest, or do not invest enough, for fear of the stock market's wild gyrations. Other people do not invest, or do not invest enough, for fear of the tax man eating up any gains.

These people may want to take a look at the various tax free investments available today. There's a lot to like here.

Tax Deferred CDs

Certificates of Deposit called "tax free" are not really tax free, but tax deferred. That is, the interest earned is not taxed immediately, but at a later date, when the CD is cashed out. For example, let's say that the stock market's behavior is scaring you lately. You're approaching retirement age, though, and your employer even matches a portion of your 401K contributions.

What should you do?

One answer is to keep investing in your 401K, but instead of putting the money in stocks, use boring old CDs to grow your retirement nest egg slowly but surely. That way, you get the tax deduction for 401K contributions without the stomachache of the stock market's ups and downs.

When you withdraw the money from your 401K, the interest earned on such a CD becomes taxable. But then you'll be retired, so your tax rate should theoretically be lower.

Money Market Funds that Purchase Municipal Bonds

For a simple and truly tax free investment, consider buying into a money market fund that purchases municipal bonds issued by the state in which you live.

When you buy municipal bonds issued by your home state, you pay neither federal nor state income tax on the investment gains. The same is true when you purchase a money market fund that buys those bonds. And no, that's not a typo: you pay neither state nor federal income tax. The returns and risks on municipal bonds can vary quite widely. This is one advantage of buying into a money market fund rather than directly purchasing the municipal bonds themselves:

The pros have time to research which bonds are the best buys.

Another major advantage of buying a money market fund that buys municipal bonds, rather than directly purchasing the bond themselves, is the liquidity factor. A money market fund allows you to cash out quickly and easily. Cashing out the bonds themselves may be trickier.

Tax Free Investments Are Nice to Have

At the risk of mastering the obvious, not paying taxes (legally) is fantastic.

With future tax rates uncertain but likely to rise, tax free investments are more attractive than ever. Every diversified investor should be thinking about picking up a few tax free investments, but especially those investors who want to grow their money while keeping it safe, too.

Sources

Fidelity

Municipal Finance Journal