bond alternatives in a taxable account

[edt]

Putting bonds into a 401k account makes a lot of sense because of the taxation implication.

What alternatives are there for a regular taxable account that would have a similar risk/reward profile without the tax implications for someone in the higher tax bracket? Munis seem too volatile.

In my situation, I have 150K I would like to invest, but don't want to commit it to a retirement account because I am likely to upgrade my house due to a growing family within 2-3 years. Vanguard Total Bond Market ETF would be perfect if it was more tax efficient (a 10% capital hit in another 2008 meltdown is acceptable to me but not a 50% demolition like there were in stocks since I need it in the medium term).

Anyone have some good advice?

[grabiner]

Putting bonds into a 401k account makes a lot of sense because of the taxation implication.

What alternatives are there for a regular taxable account that would have a similar risk/reward profile without the tax implications for someone in the higher tax bracket? Munis seem too volatile.

Munis are not inherently any more volatile than other bonds; you can decide how much risk you want to take with your munis, by using short-term or long-term funds. If you plan to spend the money in 2-3 years, then Limited-Term Tax-Exempt is a natural choice.

Another alternative is I-Bonds; there is a limit of $10,000 per year, and they cannot be redeemed in the first year after purchase, with a small penalty if redeemed within five years. I-Bonds are exempt from state tax, and the federal tax is deferred until you redeem them so if you have I-Bonds which you don't need to spend, they can grow tax-deferred for 30 years.

[DaveS]

Like the man said, you don't want your duration to be longer than the period till you need the money, thus the Vanguard limited term tax exempt is a good choice. If you want to hold your nose and pay some taxes Vanguard Short Term Investment Grade has about the same duration, but higher yield. You won't make a lot of money with any short term bond fund, but the money will be there when you want it. Dave

[dratkinson]

Putting bonds into a 401k account makes a lot of sense because of the taxation implication.

What alternatives are there for a regular taxable account that would have a similar risk/reward profile without the tax implications for someone in the higher tax bracket? Munis seem too volatile.

In my situation, I have 150K I would like to invest, but don't want to commit it to a retirement account because I am likely to upgrade my house due to a growing family within 2-3 years. Vanguard Total Bond Market ETF would be perfect if it was more tax efficient (a 10% capital hit in another 2008 meltdown is acceptable to me but not a 50% demolition like there were in stocks since I need it in the medium term).

Anyone have some good advice?

(1) I'm against the idea of taking any money out of any retirement account until needed for retirement purposes because it's too hard to get money into such an account. (Mine may be a minority position.)

(2) If the TBM ETF is acceptable to you in a taxable account, then consider a bank CD. You will lose the principle volatility. But you will be exposed to the high-tax-bracket hit. If principle protection is your greatest concern, this is a good choice.

(3) *If tax efficiency is your greatest concern, I'd use a ST tax-exempt bond fund. But the price volatility returns. You could lose ~1% in principle over 2 years assuming a 1% increase in the federal lending rate over that time frame. (No, I don't have any idea how likely that is to happen.)

*If you are subject to the AMT (alternative minimum tax), the TE-interest becomes taxable. But luckily, there will be little of it.

[Bob's not my name]

If you are subject to the AMT (alternative minimum tax), the TE-interest becomes taxable.

The Vanguard national muni funds don't invest in bonds subject to AMT (as a matter of practice, not policy, if I recall correctly), with the exception of the High Yield Tax Exempt Fund.

[dratkinson]

If you are subject to the AMT (alternative minimum tax), the TE-interest becomes taxable.

The Vanguard national muni funds don't invest in bonds subject to AMT (as a matter of practice, not policy, if I recall correctly), with the exception of the High Yield Tax Exempt Fund.

I knew that. Got ahead of myself.

(4) Tax-exempt MMkt fund. Principle almost guaranteed not to break the buck. Interest (very little) fed tax exempt. Vanguad's does contain an AMT exposure. (<=20% if memory serves.)

[brisni]

If you are concerned about volitility, why not a 2 or 3 year CD? Yes, you will pay income taxes, but if you shop around you can
get an interest rate to compensate. Check out www.depositaccounts.com for best rates.

Another idea: if you currently have a mortgage you can prepay principal.

- Brian

[edt]

Thanks all for some of the great ideas and opinions everyone - I have learned a lot. I am leaning towards the tax exempt funds, it looks like it will meet my requirements of risk/reward for a medium time frame.