Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

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VeremchukA
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Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by VeremchukA »

I am curious what I am missing here. Instead of using my Ally online savings account that pays 1% and the dividends are taxable why not use the Vanguard Intermediate-Term Tax-Exempt Fund? The expense ratio for Investor shares is just 20 basis points. I am in the 15% federal tax bracket. Perhaps last year's return was so high partly if not mostly due to capital appreciation since the fund is at a 52 week high. This would be in a taxable account for parking about $4,000 in cash that I am not using vs putting it in my Ally account. I know bond funds are better held in tax deferred or tax free accounts but being a tax free account I thought holding it in a taxable account is ok re taxes. I do understand nav can change and the duration is 5.3 years and what that means. With Bernacke announcing the holding of Fed funds rates low thru 2014 this seems like a way to get a better yield and the dividends are tax free at the federal level. This would be a holding for a year or 2 not a long term holding. Heck last year the return was 9.6%.

Am I missing something that says this is a bad idea?
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Kevin M
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by Kevin M »

VeremchukA wrote:I am curious what I am missing here. Instead of using my Ally online savings account that pays 1% and the dividends are taxable why not use the Vanguard Intermediate-Term Tax-Exempt Fund? ... snip ... I do understand nav can change and the duration is 5.3 years and what that means.
You answered your own question. Duration of 5 years -> NAV will fall 5% with a 1% increase in interest rates. FDIC accounts are risk free, a bond fund is not.
With Bernacke announcing the holding of Fed funds rates low thru 2014 this seems like a way to get a better yield and the dividends are tax free at the federal level.
As Taylor (one of the forum founders) often says, higher yield comes with higher risk (although I think FDIC-insured accounts vs. treasuries is an exception). The Fed influences rates, it does not control them. Intermediate-term muni rates could rise despite what the Fed does.
This would be a holding for a year or 2 not a long term holding.
I would not hold a bond fund with a duration of 5 years for money needed in 1 or 2 years.
Heck last year the return was 9.6%.
Last year is not predictive of next year, or the following years. Interest rates cannot fall forever.
Am I missing something that says this is a bad idea?
I think the answer is yes.

Incidentally, I own both CDs and a variety of bond funds, including munis, with a variety of durations, but I don't keep money in bond funds that I expect to spend in the next few years (others do of course).

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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lmpmd
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by lmpmd »

For expenses in 2 yrs this is kinda risky. The tax free short term bond fund would be better probably - but still you have to think about the risk.
am
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by am »

If you are ok with potentially losing principal than munis are fine. How much is anyones guess but look at the NAV drops in this fund during the early years (late 70s, early 80s). Pretty shocking. A couple of high profile defaults and muni funds may take a big hit.
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VeremchukA
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by VeremchukA »

Thanks.

The money is not needed in 2 years, I might need some before that for various expenses. I said 2 years because that's how long the Fed will keep rates at this low level thinking in later 2014 moving funds out of this fund.

I understand this fund does not have FDIC insurance like Ally online savings account does.

The duration aspect, yes 5.3% increase if the interest rate went up 1% but the guess (skillfully avoiding the assumption word!) is that rates will remain steady. Of course no one knows.

Boy it sure was a no brainer last year on this date!

edited to add - while the Fed does not control longer term rates just the over night rate banks use to lend to each other, has anyone seen savings accounts or bond fund yields rise over the past couple of years with the Fed fund rate being held at 25 bp? I am not talking cap appreciation due to falling interest rates that bond funds have enjoyed but the interest rates themselves being raised? Seems the Fed influences longer term rates even if it does not control them.
Last edited by VeremchukA on Sat Jan 28, 2012 10:59 pm, edited 1 time in total.
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tfb
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by tfb »

VeremchukA wrote:This would be a holding for a year or 2 not a long term holding.
Nobody knows what will happen in a year or two. I imagine whoever says this is a bad idea won't make up for you if the bond fund ends up doing better than the savings account. Whoever says it's a good idea won't make up for you either if the bond fund has a loss. You have to weigh the risk against the potential higher return. I have no idea which way it will go.
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Kevin M
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by Kevin M »

VeremchukA wrote:The duration aspect, yes 5.3% increase if the interest rate went up 1% but the guess (skillfully avoiding the assumption word!) is that rates will remain steady. Of course no one knows.
You pays your money (and you takes your chances)
If I make a calculation error, #Cruncher probably will let me know.
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jasonv
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by jasonv »

Ordinarily, investors in the 15% tax bracket would not be considered candidates for municipal bonds. However, I do believe that the current yield environment does give preferences to munis. What concerns me is that you said that you have a two year time horizon, but the duration of the fund is over 5 years. The primary difference between cash (such as a savings account) and bonds is that bonds can decline in value when not held to maturity.

VWITX has had one periods of rolling 2 year declines in the late 70s, with a loss of as much as 12% (see the chart linked below). Are you really prepared for this level of risK?

http://quote.morningstar.com/fund/chart ... %2C0%22%7D

I am not saying that declines on that order of magnitude are likely in the near term, but losses should be expected to occur from time to time.

Full disclosure: I do not own this fund, but I do have some Vanguard Limited-Term Tax-Exempt, which has a duration of under 3 years.
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stevewolfe
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by stevewolfe »

VeremchukA wrote:Boy it sure was a no brainer last year on this date!
No it wasn't. What may not be obvious about the chart from a year ago is that we were in the aftermath of the Meredith Whitney prediction that there would be massive Muni Fund defaults, etc and there was a flight out of Municipal bonds. That dip at the end of 2010 to beginning of 2011 is what set up last years nice return. No such dip recently and, like you said, now trading at 52 week high.
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Taylor Larimore
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by Taylor Larimore »

Hi VeremchukA:

Your Ally Guaranteed Savings Account and an Intermediate-Term tax-exempt bond fund are not comparable. A Federally Guaranteed Savings Account has never lost money.

During 1981, Vanguard's Intermediate-Tax-Exempt Bond fund plunged -20.6%.

I respectfully suggest that you read a good book about bonds like this one:

The Only Guide to a Winning Bond Strategy

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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VeremchukA
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by VeremchukA »

stevewolfe wrote:
VeremchukA wrote:Boy it sure was a no brainer last year on this date!
No it wasn't. What may not be obvious about the chart from a year ago is that we were in the aftermath of the Meredith Whitney prediction that there would be massive Muni Fund defaults, etc and there was a flight out of Municipal bonds. That dip at the end of 2010 to beginning of 2011 is what set up last years nice return. No such dip recently and, like you said, now trading at 52 week high.
What I meant was a year ago it would have been a good move to have put money into the fund, a no brainer in hindsight. I did not mean to imply that it was obvious then, it was not.

And Taylor, thank you, I read that book by Larry about 5 years ago. Just looking for a better return on extra cash just parked not being used with no specific use yet but might be needed if situation arose, otherwise it is just cash, extra cash. Just swapping 1 savings account at Ally for a different one BUT I do understand the differences and they are not equals, I fully understand and did not mean imply they were interchangeable cuz they sure are not. With the yield of 1.96%, even being tax free, I guess it is not worth the risk of nav loss because it can happen. The big return last year was no doubts due to falling interest rates and perhaps fear of muni bonds ala Meredith Whitney.
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lmpmd
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by lmpmd »

"What I meant was a year ago it would have been a good move to have put money into the fund, a no brainer in hindsight."

I'm not sure this logic is ever very useful in investing. Because we are always investing in real time and don't know the future. A year ago it still had more risk than a FDIC insured bank account. So one always has to think about a time horizon and a overall plan for one's money.
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VeremchukA
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by VeremchukA »

I agree, it was just an observation, just what if you had done this then... not that anyone could have known but doing it was like stepping in $^@! :shock:
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Hector
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by Hector »

why not putting your money into limited term tax exempt fund?
of course, its yield is less than intermediate term, but so does duration and risk. Yield for limited term is more than Ally.
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Kevin M
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by Kevin M »

Hector wrote:why not putting your money into limited term tax exempt fund?
That probably would be more appropriate for short-term reserves.
Yield for limited term is more than Ally.
As of today, SEC yield for Vanguard Limited-Term Tax-Exempt Bond fund is 0.73%, and Ally Online Savings APY is 0.84%, so depending on your marginal tax rate, LT TE could be slightly higher after-tax yield; but enough to compensate for the credit and term risk?
If I make a calculation error, #Cruncher probably will let me know.
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lmpmd
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Re: Intermediate-Term Tax-Exempt Fund vs Ally Online Savings

Post by lmpmd »

As you can see the VG short term TE has a bit of a smoother ride than the limited - as you are comparing it to an FDIC insured bank account:
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