For investors who must pay taxes on their investment income, the process of asset allocation is complicated by the fact that they pay income taxes only on certain kinds of investment income.

Interest income on munis is exempt from tax, and high-tax-bracket investors will prefer to hold them rather than short- and long-term taxable bonds. The more complex aspect of taxes is the fact that capital gains are taxable only if realized through the sale of an asset during the holding period. L02