Bonds in taxable account, etc.

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Callalily
Posts: 32
Joined: Wed Dec 16, 2009 11:42 am

Bonds in taxable account, etc.

Post by Callalily »

I'm sure this has been asked before, but I wasn't able to find a relevant thread.

I'm wondering
(i) How would one decide whether it is better to buy a taxable bond fund or a tax-exempt bond fund to be placed in a taxable account?
(ii) What would be a good Vanguard tax-exempt bond fund?

Another question that has nothing to do with bonds:
I was told by Vanguard that although there's a $3000 minimum to open a fund, it's actually possible to transfer from one fund to another and just keep a minimum of $1000 in the original fund. In other words, suppose I have $4000 in Total Stock Market Index, I could transfer $3000 of that into Total International Stock Index, leaving only $1000 in Total Stock Market Index. Are there any tax consequences to this if I do this within two days, before there's much dividends and capital gains?
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grabiner
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Re: Bonds in taxable account, etc.

Post by grabiner »

Callalily wrote:I'm sure this has been asked before, but I wasn't able to find a relevant thread.

I'm wondering
(i) How would one decide whether it is better to buy a taxable bond fund or a tax-exempt bond fund to be placed in a taxable account?
Compare the after-tax yields on funds of comparable risk. Intermediate-Term Bond Index yields 3.69%, and if you are a 25% tax bracket, that is 2.77% after taxes. Intermediate-Term Tax-Exempt yields 2.93%, and has about the same risk.

Remember to compare funds of comparable risk. Intermediate-Term Investment-Grade yields 4.09%, which would be 3.07% after taxes, but it is somewhat riskier and thus is not a fair comparison.
(ii) What would be a good Vanguard tax-exempt bond fund?
The one for your state if you live in a high-tax state; otherwise, whichever one matches the duration of bonds you need. Intermediate-Term Tax-Exempt is the usual substitute for Total Bond Market Index or Intermediate-Term Bond Index. If you have a shorter-term need, Limited-Term Tax-Exempt may be better.
In other words, suppose I have $4000 in Total Stock Market Index, I could transfer $3000 of that into Total International Stock Index, leaving only $1000 in Total Stock Market Index. Are there any tax consequences to this if I do this within two days, before there's much dividends and capital gains?
There are no direct tax consequences (any gains or losses would be small), but Vanguard could liquidate the $1000 fund for you, which would result in a sale. I wouldn't recommend doing this; where you put $1000 has little effect on the final value of your portfolio.
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gouldnm
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Post by gouldnm »

Grabiner summed it up pretty well. There are two things I might add:

While I agree that putting money into a municipal bond fund for your state (if there is one) is a good idea, you might want to break it out between that and another bond fund such as intermediate-term or limited-term tax exempt. That way if the economy of your state tanks, you'll still be in good shape. Always a good idea to diversify rather than putting all your eggs in one basket.

Of course, if you only have a small amount of money to invest, that might not be possible, but it's something to be aware of in the long run.

Also, long-term bonds have more risk than intermediate-term bonds which have more risk than short-term bonds.

In my taxable account, I use two bond funds, the intermediate-term tax exempt and limited-term tax exempt. The intermediate-term fund has about twice as much as the limited-term. I use the latter for payments I know are coming in the near future: home improvement projects, buying a new car, etc.

Hope this helps.
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