Tax Exempt or Taxable; Am I Foolish?
Tax Exempt or Taxable; Am I Foolish?
High Fed Tax bracket. Tax deferred space full. Need FI in taxable account to maintain AA. Tax exempt calculator says go with Muni. However, am I foolish for wanting to go with a taxable bond fund rather than a national muni fund?
My understanding is that muni’s make up about 10% of the bond market and that the issuers have large unfunded liabilities. Whether this is a rational concern it does give me pause in considering muni funds.
I understand that Total Bond sailed right through the 2008-2009 market, but do not know what happened to muni funds.
Cannot decide whether I should go with Inter-Term Tax Exempt Adm (VWIUX) or Total Bond Admiral (VBTLX) in the taxable account. I know that costs and taxes are important. Appreciate your thoughts on going taxable or tax exempt.
My understanding is that muni’s make up about 10% of the bond market and that the issuers have large unfunded liabilities. Whether this is a rational concern it does give me pause in considering muni funds.
I understand that Total Bond sailed right through the 2008-2009 market, but do not know what happened to muni funds.
Cannot decide whether I should go with Inter-Term Tax Exempt Adm (VWIUX) or Total Bond Admiral (VBTLX) in the taxable account. I know that costs and taxes are important. Appreciate your thoughts on going taxable or tax exempt.
Last edited by Mycasino on Fri Feb 07, 2014 12:51 pm, edited 1 time in total.
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Re: Am I Foolish For ….?
Here's a link to Historical Returns page for Intermediate Term Tax exempt VWIUX that shows capital return, income return, total return:Mycasino wrote:I understand that Total Bond sailed right through the 2008-2009 market, but do not know what happened to muni funds.
https://personal.vanguard.com/us/funds/ ... INT#tab=1a
Historical returns page for Total Bond Admiral:
https://personal.vanguard.com/us/funds/ ... INT#tab=1a
Another option for fixed income outside of tax advantaged accounts is I bonds.
http://www.bogleheads.org/wiki/I_savings_bonds
Re: Tax Exempt or Taxable; Am I Foolish?
The yearly limit on i bonds will not make a dent in what I need to allocate to FI in taxable.
Re: Am I Foolish For ….?
Mycasino: it's not foolish to worry about munis, they are not nearly as safe as Total Bond or Treasuries, but they are significantly more rewarding. The question is, how much of your portfolio will be exposed to this risk, considering you still have the tax-advantaged bonds in the picture.
I'm in a similar situation, with almost twice as many bonds in taxable than tax-advantaged. While I find the muni yields very hard to resist, I did not want to go above 50% or so or my overall bond allocation; I chose to hold very safe instruments (combination of a Treasury fund and cash) alongside the munis and live with the tax hit. Treasuries have the advantage of avoiding state taxes and they are pure concentrated safety, maximizing the counterbalancing effect of that taxable space. Cash (say, a 1% savings account) is better on the very short end of the yield curve, below 3 years or so, and a good fit for money you want to be available immediately.
If this sort of calculation comes out to be 100% munis in taxable for you, don't fret too much about the availability of safe bonds in the taxable accounts. You can still use the tax-advantaged account for rebalancing or withdrawals without taking a loss, by buying back there whatever it is you're selling in the taxable account.
I'm in a similar situation, with almost twice as many bonds in taxable than tax-advantaged. While I find the muni yields very hard to resist, I did not want to go above 50% or so or my overall bond allocation; I chose to hold very safe instruments (combination of a Treasury fund and cash) alongside the munis and live with the tax hit. Treasuries have the advantage of avoiding state taxes and they are pure concentrated safety, maximizing the counterbalancing effect of that taxable space. Cash (say, a 1% savings account) is better on the very short end of the yield curve, below 3 years or so, and a good fit for money you want to be available immediately.
If this sort of calculation comes out to be 100% munis in taxable for you, don't fret too much about the availability of safe bonds in the taxable accounts. You can still use the tax-advantaged account for rebalancing or withdrawals without taking a loss, by buying back there whatever it is you're selling in the taxable account.
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Re: Tax Exempt or Taxable; Am I Foolish?
So does the federal government.Mycasino wrote:
My understanding is that muni’s make up about 10% of the bond market and that the issuers have large unfunded liabilities.
Aside from that, is this something that only you are aware of? Or does everyone know it, and yields have adjusted upwards to compensate? Or perhaps you feel the higher yields do not properly compensate for the risk - and you know more than the market as a whole.
FWIW, I like ogd's approach, stated immediately above.
Best regards, -Op |
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"In the middle of difficulty lies opportunity." Einstein
Re: Tax Exempt or Taxable; Am I Foolish?
odg: About 20% of my overall bond allocation will be in taxable.
Call_Me_Op: I am sure I have less knowledge than the market as a whole, just uncertain whether I am willing to accept the higher risk for preferential tax treatment. Trying to get a handle on how to evaluate it and hoping to hear how others on this board have approached the issue.
Call_Me_Op: I am sure I have less knowledge than the market as a whole, just uncertain whether I am willing to accept the higher risk for preferential tax treatment. Trying to get a handle on how to evaluate it and hoping to hear how others on this board have approached the issue.
Re: Tax Exempt or Taxable; Am I Foolish?
I'm 72 years old, retired and 80% in bonds, 15% stocks and 5% cash.
My bond allocation: 50% municipals (limited-term, intermediate term and high-yield), 25% corporate (intermediate-term investment grade and high-yield) and 25% GNMA. According to many that post here, I'm taking too much risk with my bonds. "You should take risk with your equities, but not your bonds". I'm mainly municipals and corporates, with only 25% in bonds backed by the full faith and credit of the US government. I don't buy the argument that you have to take all, or nearly all, of your risk on the equity side. What's wrong with taking some of your overall risk on the bond side? The overall default rates on corporate and municipal bonds, even those below investment grade, do not give me much pause, especially if my bonds are being selected by the pros at Vanguard and Wellington Management.
So go with some munis!
My bond allocation: 50% municipals (limited-term, intermediate term and high-yield), 25% corporate (intermediate-term investment grade and high-yield) and 25% GNMA. According to many that post here, I'm taking too much risk with my bonds. "You should take risk with your equities, but not your bonds". I'm mainly municipals and corporates, with only 25% in bonds backed by the full faith and credit of the US government. I don't buy the argument that you have to take all, or nearly all, of your risk on the equity side. What's wrong with taking some of your overall risk on the bond side? The overall default rates on corporate and municipal bonds, even those below investment grade, do not give me much pause, especially if my bonds are being selected by the pros at Vanguard and Wellington Management.
So go with some munis!
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Re: Tax Exempt or Taxable; Am I Foolish?
Not sure what your state tax rate is? I live in a no income tax state. That coupled with the fact that I prefer the diversification of total bond to a muni fund sways me away from munis. I still have tax deferred space for bonds though. I have also mostly invested in the low interest rate environment so I am influenced by that as well.
Re: Tax Exempt or Taxable; Am I Foolish?
At 20% I'd just use munis. The other 80% can do the heavy lifting when safety is required. Like I said, the money can be used to rebalance into investments currently in taxable by doing mirroring trades.Mycasino wrote:odg: About 20% of my overall bond allocation will be in taxable.
Call_Me_Op: I am sure I have less knowledge than the market as a whole, just uncertain whether I am willing to accept the higher risk for preferential tax treatment. Trying to get a handle on how to evaluate it and hoping to hear how others on this board have approached the issue.
It's very hard to evaluate the risks and rewards yourself. After all, the market doesn't just look at a quantifiable number like credit rating AA, it's trying to guess the exact chance of default, or higher interest rates, bonds being called, tax-exempt status revoked, etc. Currently the risk is perceived as high, the premium almost overcoming the tax savings discount (normally munis yield quite a bit less than TBM).
I usually approach this from a different angle: are you getting a better deal than other investors who are using municipal bonds and buying at these prices in preference to corporates, etc? This of course depends on your tax rate. I feel relatively safe saying that in the 33% bracket and up you are probably getting a better than average deal. But I'll be the first to admit that I have no source for that number, and I'd be interested in seeing an evaluation (i.e. survey of weighted average tax rate of muni investors) if such exists.
In the maximum tax rate, there's no way one can get a worse than average deal, so that would seal the deal.
Re: Tax Exempt or Taxable; Am I Foolish?
It's true that munis are federal tax-free, but they're also more volatile than treasuries. Take a look at the big swings. Also keep in mind that as interest rates go up, munis will likely go down (though yields will rise) faster than treasuries.
Re: Tax Exempt or Taxable; Am I Foolish?
Here's a take on taxable bonds that you may find useful: http://whitecoatinvestor.com/asset-loca ... n-taxable/
Re: Tax Exempt or Taxable; Am I Foolish?
I would use a national muni fund for 1/5th of my bonds without worry. I would not put a huge chunk of my money into some of the state munis, but I might use some.
Link to Asking Portfolio Questions
Re: Tax Exempt or Taxable; Am I Foolish?
This depends on your tax bracket. My rule of thumb is that munis are priced to break even with taxable bonds of comparable risk in the 25% bracket, so a muni fund yielding 2.25% is as risky as a corporate fund yielding 3%. If you are in a higher bracket than 25%, or can use a muni fund for your state, then munis are probably better. Conversely, if you are in a high-tax state, Treasury bonds (particularly TIPS) may be a better deal in your taxable account because they are exempt from state taxes.Mycasino wrote:High Fed Tax bracket. Tax deferred space full. Need FI in taxable account to maintain AA. Tax exempt calculator says go with Muni. However, am I foolish for wanting to go with a taxable bond fund rather than a national muni fund?
Re: Tax Exempt or Taxable; Am I Foolish?
On the positive side, investment grade municipal bonds actually have a very low default rate. However, there can be a liquidity problem in the municpal bond market if there are a lot of sellers and a shortage of buyers. That can occur when tax exempt mutual funds see significant redemptions. The same thing occurs in the high yield corporate market. Check the charts during periods of crisis such as 2008 or the end of 1994 when Orange County, California defaulted on its debt. Higher volatility will be seen in less conservative funds and longer maturity funds.
Dealers don't like to step in and buy for inventory if they believe prices will continue to drop. There are also fewer bond dealers today to support the market and bid prices drop until prices are very attractive.
Here is a Morningstar chart comparing Vanguard Total Bond Market Index (VBMFX) and Vanguard Intermediate Term Tax Exempt (VWITX). You can change the time scale. One needs to mentally adjust the chart to compensate for the tax exempt nature of VWITX.
http://quote.morningstar.com/fund/chart ... %2C0%22%7D
Dealers don't like to step in and buy for inventory if they believe prices will continue to drop. There are also fewer bond dealers today to support the market and bid prices drop until prices are very attractive.
Here is a Morningstar chart comparing Vanguard Total Bond Market Index (VBMFX) and Vanguard Intermediate Term Tax Exempt (VWITX). You can change the time scale. One needs to mentally adjust the chart to compensate for the tax exempt nature of VWITX.
http://quote.morningstar.com/fund/chart ... %2C0%22%7D
Enjoying the Outdoors
Re: Tax Exempt or Taxable; Am I Foolish?
Check out BMBIX... lots of prerefunded munis (50%+). So the security of treasuries... the tax benefit of munis... and a return that reflects the risk (but the tax benefit helps it).
(I have both muni funds and BMBIX)
(I have both muni funds and BMBIX)
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Tax Exempt or Taxable; Am I Foolish?
I use a combination of iBonds, MUB (intermediate term national muni ETF), and a 0.75% savings account to cover my needs for "taxable" FI. Once you have a very strong liquid position in iBonds and Savings Accounts, the incremental volatility of MUB doesn't really matter - and the higher after-tax distributions are very nice.
Stay the course. If you can't resist greed, and fear is proven to be 2x as strong, you are doomed as an investor.
Re: Tax Exempt or Taxable; Am I Foolish?
The holdings in Corporate bonds and other lower credits did impact performance in 2008. That negative performance was offset by holdings in Aaa and Government credits.Mycasino wrote:I understand that Total Bond sailed right through the 2008-2009 market, but do not know what happened to muni funds.
You might review the holdings of the bond index and the credit ratings which span the range from Baa to Aaa and U.S. Government.
https://personal.vanguard.com/us/funds/ ... =INT#tab=2
Note that the bond index holds a lot of lower yielding Treasury and Agency bonds and a lot of Mortgage bonds. There are asset backed bonds and even foreign bonds (6.5%) in the portfolio. Corporate bonds appear to have a relatively low weighting.
Enjoying the Outdoors