Hirsch said he likes the steady income he receives from his municipal bonds, which account for about 20% of his portfolio.

"What I'm interested in is at a bare minimum preserving capital, and a predictable return," he said.

Mutual funds may provide investors with better diversification than they can get building a portfolio of bonds on their own, and may be more cost-effective, said Morningstar's Sjoblom.

Trading Costs

"There's no transparency as far as trading costs go when you have a broker buying or selling bonds. You don't know if you're getting a good deal or not, and usually you're not," she said. Sjoblom said investors should consider mutual funds from Fidelity Investments including Fidelity Municipal Income, which primarily holds investment-grade municipal bonds and has an average maturity of 11 years.

Mutual-fund investors may experience more volatility than holders of individual bonds since mutual funds must price their portfolios to market every day, said David Kotok, chief investment officer of Sarasota, Fla.-based Cumberland Advisors, which manages about $1.5 billion.

Greg Serbe, a municipal-bond portfolio manager for Lebenthal & Co., recently invested about $1 million in New York State Dormitory Authority bonds rated AA- by Standard & Poor's that mature in 2018 and pay a 5% coupon. He said that such high-rated short- and intermediate-term bonds have been hard to find.

New Issuance

"New issuance has fallen off the face of the earth," said B. Craig Elder, a fixed-income senior analyst for Milwaukee-based Robert W. Baird & Co. Private Wealth Management, which manages almost $63 billion. Elder said he has been purchasing general-obligation bonds from AAA rated states such as Missouri for Baird's clients.

About $45 billion in municipal securities were issued in the first three months of 2011, compared with about $87 billion in the first quarter of 2010, according to Thomas Doe, chief executive officer at Concord, Mass.-based Municipal Market Advisors.

Fred Bacani said he has been purchasing pre-refunded municipal bonds, whose coupons and principal payments are backed by U.S. Treasury bonds held in escrow, for higher pretax yields than Treasury bonds of similar maturities. Bacani is head of fixed-income trading for Newtown Square, Pa.-based Veritable, which manages about $10 billion and whose clients have $20 million or more to invest.