Vanguard inter-term tax-exempt vs high-yield tax-exempt

[longview]

VWIUX vs VWALX

Both are tax-free munis. Both are well diversified. And the high-yield is ranked as slightly higher risk and much higher return. It's not like major defaults would cripple the high-yield fund -- or is it?

This is all in taxable. Would you add any high-yield tax-exempt?

[grabiner]

The high-yield fund has its higher yield for two reasons: longer duration and lower quality. Both of these are fundamental risks with bonds. Duration is a measure of the interest-rate risk; if a fund has a six-year duration and the yields on its bonds rise by 1%, the fund will lose 6%. And quality is the risk that bonds will default (or be downgraded and be sold before they have a chance to default or recover). You can see the effect of both types of risks by comparing High-Yield Tax-Exempt, Long-Term Tax-Exempt (better quality but same duration), and Intermediate-Term Tax-Exempt in 2008.

Thus there is no free lunch. The high-yield fund has higher expected returns but more risk. If you are holding bonds to reduce the risk of an all-stock portfolio, you need more of the high-yield fund to get the same reduction.

It's still a fine fund as long as you recognize the risk. (The name is a misnomer; it isn't a junk-bond fund, but it has a higher yield than most other municipal-bond funds because it has very low expenses and medium-quality bonds.)

[Bob's not my name]

The High Yield fund has AMT exposure.

[Dale_G]

Another option is the Vanguard Long Term Tax-Exempt fund. The duration is 5.9 years versus 4.9 years for the intermediate fund. The SEC yield is a little more than .5% higher and the credit quality is similar.

I hold the intermediate fund, but recently added the "long" term fund. An additional half percent return at the cost of an additional year of duration seems to be a reasonable trade off. But, I'm not going to be surprised if I end up recognizing a capital loss a few years down the line.

Dale

[longview]

Thanks. Makes sense. I think I'll keep my bonds conservative and let my equity exposure be my risk.