Bond Allocation for Portfolio mostly in Taxable

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bogle2013
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Bond Allocation for Portfolio mostly in Taxable

Post by bogle2013 »

I've converted our portfolio from mostly individual stocks to the 3 fund portfolio. 60% in stocks now (combination of Total Stock Market and International Stock Market). 40% of our bond funds is divided between (30% CD ladder, 20% ibonds/EE Savings bonds, and then the other 50% in Vanguard Intermediate Term Tax Exempt. So it comes out to:

30% Vanguard Total Stock Market
30% Vanguard Total International Stock Market
20% Vanguard Intermediate Term Tax Exempt
12% Ally CD Ladder and Savings Account
8% I-bonds/EE Savings Bonds (we buy $80k a year using our kids social security numbers)

We do not have enough Tax advantaged space to make a difference. Almost all of our income comes from dividends and capital gains, so there is not much chance of growing that space anytime soon. We have maxed out the 529 plans for both kids invested conservatively in age based options and we do not count that in our AA.

I am concerned about having such a concentration in the Intermediate Term Muni fund. Should I be? Any thoughts would be appreciated. Thanks.
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Taylor Larimore
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Taylor Larimore »

I've converted our portfolio from mostly individual stocks to the 3 fund portfolio. 60% in stocks now (combination of Total Stock Market and International Stock Market). 40% of our bond funds is divided between (30% CD ladder, 20% ibonds/EE Savings bonds, and then the other 50% in Vanguard Intermediate Term Tax Exempt.
Bogle2013:

If your tax-advantaged accounts are full, placing bonds in Vanguard's Intermediate-Term Tax-Exempt Bond Fund should be a very good alternative.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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bogle2013
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by bogle2013 »

Thanks Taylor. Some days you read a bunch of articles and posts about rising rates, municipal debt/default/obligations, etc... and I get nervous.
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ogd
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by ogd »

bogle2013: the allocation you have looks great. Interm Term Tx-Ex is a widely diversified muni fund with reasonable term risk. That said, I wouldn't go above 50% of total fixed income to avoid being overly exposed to systemic risk in munis (for example, changes in their tax status or overall state finances/real estate declines).

One thing to keep in mind is that your tax bracket makes munis a better or worse deal even in taxable. The tax discount of munis does get factored into their price and yield; they are so rewarding right now only because their risk is perceived to be higher than normal (but this perception has moved a lot toward safety in the last year or so, with corresponding declines in yield). At other times, munis have yielded less than Treasuries, which are indisputably safer, so that past experience shows that the tax discount is reflected in the yields.

Personally, I would hold Total Bond rather than munis even in taxable below the 25% tax bracket, and I'm only certain they're a good deal above 30% or so. The objective isn't to pay the least taxes, but to get the maximum reward for your risk after tax; sometimes, that means paying higher taxes as long as they're not too high.

I don't mean to spook you out because I still think munis are quite safe and I hold a substantial amount of them. Just to put the tradeoffs on the table.
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bogle2013
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by bogle2013 »

Thanks OGD- I guess that is my concern - i'm so diversified in the stock portion, but the bond is not. Taxes are not a big problem b/c of our lack of earned income (but that could change in any given year). So ultimately I believe my goal is to eventually get to in the bond portion of the portfolio:

25% Intermediate Term Muni
25% Total Bond Market Index
25% Ally CD Ladder
25% ibonds/EE savings bonds

Of course then I start wondering if I should have International Bonds in there- and as I read the archives on that, I certainly don't get any clarity.
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ogd
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by ogd »

bogle2013: let me repeat: I'm comfortable at 50% of fixed income munis, in fact it's what I do myself. They'll do the job. Below 25%, other bonds might do the job better, but don't overthink this because the differences are likely to be small.
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retiredjg
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by retiredjg »

bogle2013 wrote:Thanks OGD- I guess that is my concern - i'm so diversified in the stock portion, but the bond is not.
Well, there are almost 4000 bonds in that fund so it is not completely un-diversified.

You could get some diversification by holding a portion in a shorter or longer term bond fund.

I know it goes against conventional wisdom, but if taxes are not much of a concern, why not just hold total bond in your taxable account?

Or if taxes do become a concern again, is this a case where holding Vanguard's Total Bond Variable Annuity would be reasonable? The expense ratio is .49% which is high by VG standards, but not so high by industry standards. I don't know how to figure out if it is better just to pay tax or the higher expense ratio.
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Kevin M
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Kevin M »

I would favor a direct CD earning 2.25% or 2.3% to total bond fund with SEC yield of 2.08%. SEC yield on int-term tax-exempt bond fund is about 1.8%, so at a 25% marginal tax rate the CD after-tax yield is 2.3% x (1-.25) = 1.73%. So even at 25% marginal tax rate you're giving up very little after-tax yield with the CD, and for much less risk. Having said that, I use both CDs and tax-exempt bond funds in taxable accounts, but I'm heavily weighted toward the (safer) CDs in my fixed income (across all accounts, taxable and tax-advantaged).

Also, although I like Ally and have lots of CDS there, they have not been offering competitive CD rates for some time, and since they raised their early withdrawal penalties (EWPs), their lower rates are even less competitive. I would not use them for new CDs. Check out GE Capital Retail Bank (GECRB), GE Capital Bank (similar name, different bank), or Barclays bank, all of which offer 5-year CDs at 2.25% or more with early withdrawal penalties of six months of interest. Opening an account and transferring funds is very easy.

I'm in the process of transferring out of some bond and money market funds in an IRA at Fidelity to the 2.3% 5-year CD in a new IRA at GECRB. I'll be publishing a blog post soon with more details, including more of the thinking about why I favor CDs like this.

Finally, instead of a ladder consider simply using 5-year CDs with EWPs of six months of interest. If you do an early withdrawal from a 2.3% CD after one year, you earn about 1.15%,and after 2 years, about 1.73%, which probably are better rates than the corresponding rungs in a ladder you were to build today. Doing an early withdrawal from a Barclays CD took about five minutes on the phone, and the money was in my Barclays savings account the next day. They asked a few more questions at Ally, but it still was quick and easy.

Kevin
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livesoft
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by livesoft »

Another possibility to reduce bond-fund risk is to have some money in a short-term bond fund. One can "dial in" just about any risk level they want because Vanguard has several short-term bond funds. I like the most risk in my short-term bond fund, so I use the Short-term corporate bond index fund VSCSX / VCSH. Admiral share min is only $10K compared to a min of $50K for the Short-term investment grade bond fund with its slightly lower risk.

The returns of VSCSX have bested CD rates which makes sense since the bond fund is riskier.

One can also write that the lower yield of a short-term bond fund makes them more "tax-efficient" than an intermediate-term fund, so they may be more suitable for a taxable account if one is putting bond funds in both taxable and tax-advantaged accounts.
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Kevin M
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Kevin M »

livesoft wrote: The returns of VSCSX have bested CD rates which makes sense since the bond fund is riskier.
This statement makes no sense without some context. What time period are we looking at, and what CDs are we comparing to? More importantly, why look at past performance instead of expected return?

It's true that the recent total return, for example YTD, has been higher than a CD earning something in the ballpark of 2%, and this is true because the bond fund has more interest-rate risk, which has been rewarded so far this year. However, if you look at the slightly longer period of one year, the statement is false; total one-year return for the bond fund is 1.54%, well short of a 2% CD. Look at 3-year returns, and it may be true again, depending on the CD you're comparing it to.

More importantly, the SEC yield, which is the forward-looking indicator that is more relevant than historical returns in making investment decisions, is 1.30%. This is the number I'd pay attention to in comparing expected return of the bond fund to that of a CD.

Granted, there's no upside to the minimal interest-rate risk in the CD, whereas there is upside as well as downside to the bond fund interest-rate risk. So if you're looking for risk in your fixed income, bond funds definitely are the way to go. However, assuming a lower-bound of 0% for yield, the upside is quite limited, and the downside is much less limited. I don't like that asymmetry.

Kevin
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livesoft
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by livesoft »

Thanks for the reply. I apologize for baiting you.
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Kevin M
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Kevin M »

livesoft wrote:Thanks for the reply. I apologize for baiting you.
Funny. I've noticed some of your other posts about the great bond fund returns of late, and have resisted commenting until now. :twisted:

Kevin
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livesoft
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by livesoft »

They have been great though, haven't they? :)
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Kevin M
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Kevin M »

Yes, which is one reason I just moved more money from bond funds to a CD. Isn't market timing fun?

Kevin
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livesoft
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by livesoft »

This thread prompted me to review our fixed income assets. I must say that I am satisfied with what we have which has been simplified over the years to:
09% GNMA
13% TIAA traditional (paying about 3.6% on average after purchasing more recently)
36% Total Bond
42% Short-term corporate

So with only 45% of fixed income in intermediate-term, you can see where my sentiments lie. I have clearly not made a killing in fixed income YTD, but I have not been disappointed either. I will be buying more TIAA TA paying 3% soon. I suppose that's like buying a CD, except it pays more and I don't have to worry about FDIC limits. :)
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Toons
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Toons »

Kevin M wrote:Yes, which is one reason I just moved more money from bond funds to a CD. Isn't market timing fun?

Kevin
+1 :happy
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Kevin M
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Kevin M »

livesoft wrote:I have clearly not made a killing in fixed income YTD, but I have not been disappointed either.
Were you disappointed with Total Bond Market return of -2.15% in 2013?

Kevin
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livesoft
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by livesoft »

Kevin M wrote:
livesoft wrote:I have clearly not made a killing in fixed income YTD, but I have not been disappointed either.
Were you disappointed with Total Bond Market return of -2.15% in 2013?

Kevin
Sort of, but perhaps more so with the return of the GNMA fund. OTOH, there is my post about shortening my duration: http://www.bogleheads.org/forum/viewtop ... 2#p1638192 Also, I can lose more than 2% in a single day with some small-cap value or emerging markets funds that I own. I'm used to it.

Overall I had a less than 1% loss in my fixed income assets in 2013.
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Bustoff
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by Bustoff »

Well, as Dr. Bernstein said, if you fear inflation and keep your bond maturities short and then turn out to be wrong, you've lost only a few percent of yield. But if you make the opposite bet, ignore inflation and reach for yield, and you turn out to be wrong, you could find yourself greeting people at a Wal-Mart front door.
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bogle2013
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Re: Bond Allocation for Portfolio mostly in Taxable

Post by bogle2013 »

Bustoff wrote:Well, as Dr. Bernstein said, if you fear inflation and keep your bond maturities short and then turn out to be wrong, you've lost only a few percent of yield. But if you make the opposite bet, ignore inflation and reach for yield, and you turn out to be wrong, you could find yourself greeting people at a Wal-Mart front door.
Does it matter if you time table is 20+ years? seems like a few percent a year would compound quite a bit in 20 years if you are reinvesting the dividends/income.
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