Bogleheads

indexfundfan · Joined: 20 Feb 2007 Posts: 769

For many people, the fixed income or bond portion of the portfolio is designated as the safety anchor of the portfolio during market turbulence (basically Larry's viewpoint, not Rick's).

The recommendation has been to use very high grade and short term debt instruments like treasury bond funds or even VG's invest-grade bond funds. And for investors in high tax brackets, it has been generally recommended to use municipal bond funds.

However, the recent municipal bond turmoil shows that muni's are not working as they should. Just as you hope municipal bonds can help soften the losses on the equity side, it does exactly the opposite, tanking along with equities.

Is it time to re-think the usage of municipal bond funds as part of the safety anchor?

It seems that the fact that the municipal bond market is rather illiquid and often subject to hedge fund's trading activities might make municipal bonds unpredictable during market turmoil.

What do you think?
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allenmickers · Joined: 11 Feb 2008 Posts: 427

I dont mean to say munis are worthless because I made $400 on a $10k one week investment last week, but unless your entire tax-sheltered accounts are already filled with treasury grade bonds and you still need more bonds to meet your AA, then I would consider munis.

I would rate munis as between treasury and high investment grade. They are also tax exempt. Therefore if you need more high grade bonds and you need to put them in a taxable account, consider munis.

I personally dont feel comfortable relying on any one thing for a particular part of my AA, so if theres a future liquidity problem with your muni holdings, and you need cash right away, then sell your treasury bonds while you wait for a buyer of the munis.

Gekko · Joined: 11 May 2007 Posts: 3519 Location: USA

bonds were never meant to replace money markets!

indexfundfan · Joined: 20 Feb 2007 Posts: 769

From the poll results, it appears that most don't seem to think much of the "equity-like" risk demonstrated by muni's recently. Interestingly, I suspect many would nevertheless recommend against the Vanguard high yield bond fund for its "equity-like" characteristics.
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sscritic · Joined: 06 Sep 2007 Posts: 3688

Sell low, buy high! Dump your muni-bonds for treasuries!

Does anyone see a problem here?

indexfundfan · Joined: 20 Feb 2007 Posts: 769

You can take the poll that way if you wish.

But I am asking a fundamental question about asset allocation -- whether muni's are good enough as a safety anchor.
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dbr · Joined: 04 Mar 2007 Posts: 4990

ddb · Joined: 26 Feb 2007 Posts: 4386 Location: Manhattan

Although I understand your question, I don't understand the BASIS for your question. According to the Vanguard page for VWITX, the Intermediate-Term Tax-Exempt Fund, the fund's YTD total return through 2008-03-11 is +0.04%. If a 10-week period of flat performance in an asset class causes you to rethink your asset allocation, then maybe you'd just be better off having everything in a money market!

- DDB
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indexfundfan · Joined: 20 Feb 2007 Posts: 769

Actually, I am talking about the period from Feb 22 to Feb 29 where muni's are tanking along with equities because of various factors, part of which were caused by hedge funds.

While this could be seen as a one-time event that does not last long, what would you do if it lasts longer or occur more frequently?

And by the way, I do not have muni bonds in my portfolio.
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Sidney · Joined: 08 Mar 2007 Posts: 1491

indexfundfan · Joined: 20 Feb 2007 Posts: 769

INDUBITABLY · Joined: 26 Oct 2007 Posts: 257

ddb · Joined: 26 Feb 2007 Posts: 4386 Location: Manhattan

indexfundfan · Joined: 20 Feb 2007 Posts: 769

It seems like this same issue is popping up again.
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stratton · Joined: 04 Mar 2007 Posts: 7898 Location: Puget Sound

daryll40 · Joined: 28 Feb 2007 Posts: 1804

I started to think that perhaps the market is pricing in inflation as the eventual cost of the bailouts. But your point about TIPS getting hit, which I also noticed, kinda shoots down that theory.

larryswedroe · Joined: 22 Feb 2007 Posts: 5378 Location: St Louis MO

what we are seeing is a liquidity crisis which will come to an end once the deleveraging comes to an end.
Even in the Great Depression AAA munis held up well, and this will not be anywhere near that situation when 35% of industrial production evaporated and 25% unemployment was hit

kenschmidt · Joined: 01 Mar 2007 Posts: 1000 Location: Cincinnati, OH

The truth is, sometimes everything goes down (except cash). Treasury bonds are not exempt from that either.

I own IT Muni and it is down around 5.5%. I also own High Yield Corp and it is down 20% or something like that. Oh well. My reasoning for holding them hasn't really changed.

Ken

Gekko · Joined: 11 May 2007 Posts: 3519 Location: USA

i think the lesson learned for some of us is this -

if you hold a muni bond fund, be prepared for the possibility of a significant NAV fluctuation down that may last for a relatively long time. bonds are not cash, and if you may need to withdraw the money within a short time horizon (~5 years) or can't stomach it, bonds may not be a good fit for that bucket of your money. stick with cash instead.

personally, i expected some NAV volatility, but nothing like this.

larryswedroe · Joined: 22 Feb 2007 Posts: 5378 Location: St Louis MO

Gekko
The lesson for those that did not already know it is to EXPECT the unexpected and build that into your plans to the extent possible--without avoiding all risks which dooms you to tbill returns. In effect, the Black Swans. We do know they will show up, just not when and in what form. That is why it is critical to not take more risk than one has the ability, willingness or need to take---and to not treat the unlikely as impossible---and to remember that just because something has not happened YET does not mean it cannot or will not happen.

Those are among the most important lessons I learned long ago as a manager of risk. And they are the lessons I have tried to teach here.

Gekko · Joined: 11 May 2007 Posts: 3519 Location: USA

daryll40 · Joined: 28 Feb 2007 Posts: 1804

Don't forget to add the coupon (interest payment) to your return. Year to date returns posted on the web site do not consider that.

newport1 · Joined: 27 Jun 2008 Posts: 191

What is crazy is that CA munis are yielding more on a taxable equivalent basis than similar maturity investment-grade corporates. I find it hard to believe that the default rate on CA bonds is likely to exceed that of high-grade corporates.

Gekko · Joined: 11 May 2007 Posts: 3519 Location: USA

Gregory · Joined: 20 Feb 2007 Posts: 1554

Some of the wisest investing advice I ever received about muni bonds was from a retired CPA who told me that when he purchased his [individual] bonds he did not pay attention to anything except the coupon. That's how I view the individual bonds (zero-coupon muni's) and bond funds (VWIUX, VG TIPS fund, etc.) I hold.

I suppose the market price for most muni bonds bill fluctuate to some degree, even the individual ones we hold -- but if you don't plan on selling, only collecting the coupon, then it's not as much a concern.

Gerg

(Edited for syntax)
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daryll40 · Joined: 28 Feb 2007 Posts: 1804

Kinda sorta right. It's true that your coupon goes up as prices fall.

It's sort of like owning a home and living there for 30 years. The value may go up and (like now) it may even fall. You don't care because you don't plan to move. But the value is still the value and it may, indeed, be less or more.

Sort of like the old "it's only a paper loss" argument. Yeah, paper loss but CONVERTIBLE into less REAL STUFF!

snowman9000 · Joined: 26 Feb 2008 Posts: 869

bob90245 · Joined: 19 Feb 2007 Posts: 4174

There is a real possibility that higher than normal muni yields are a signal of higher than normal risk. I wouldn't ignore the danger.

wab · Joined: 23 Feb 2007 Posts: 559

m_j_paquette · Joined: 25 Oct 2007 Posts: 59

wab · Joined: 23 Feb 2007 Posts: 559

Moody's data only goes back to 1970. It would be nice to see the worst-case cumulative default and recovery rates given all the 100-year floods we've been having.

And remember that this liquidity crunch is having two effects: increasing yields on some bonds and decreasing yields on treasuries, so we need to be careful when comparing to current treasury yields.

bob90245 · Joined: 19 Feb 2007 Posts: 4174

cheapskate · Joined: 26 Apr 2007 Posts: 212

VWSTX and VMLTX, the 2 muni funds I own have served as (relatively) safe havens amidst all of the turmoil. VWSTX is up 1.95% YTD ad VMLTX is up about 0.05% YTD. I am happy with both of these (together they formed 100% of my FI allocation).

But I did rotate from VMLTX to VIPSX. Could not resist the juicy real yields on TIPS. And longer term, I would like about 50% of my FI allocation in TIPS, just think this is a good time to move into it.

wab · Joined: 23 Feb 2007 Posts: 559

Gregory · Joined: 20 Feb 2007 Posts: 1554

DaveTH · Joined: 05 Apr 2007 Posts: 2447

wab · Joined: 23 Feb 2007 Posts: 559

Gekko · Joined: 11 May 2007 Posts: 3519 Location: USA

hey! my muni fund is *up* .02 today! it's a win! i'll take it!

Gregory · Joined: 20 Feb 2007 Posts: 1554

djw · Joined: 08 Apr 2008 Posts: 1157

newport1 wrote:

"I find it hard to believe that the default rate on CA bonds is likely to exceed that of high-grade corporates."

Is newport1 aware that the gap between California's proposed state budget expenditures and its expected tax revenues is 24%?

Arizona, Nevada, and Florida state budgets are in similar dire straits.

Has newport1 read the press reports that California's governor (a Republican) has already gone begging to Washington for a bailout?

Is newport1 aware that some CA cities and towns have previously defaulted on their bonds and that several currently appear to be on the verge of doing so in the near future?

Is newport1 aware that CALPERS and other CA entities are known to have made large, losing investment bets which are coming home to roost?

I've never owned any munis and, all things considered, I won't be buying any munis any time soon.

newport1 · Joined: 27 Jun 2008 Posts: 191

superlight · Joined: 31 Mar 2008 Posts: 1174

It will be really too bad if munis crap out, because they are the only real tax-safe retirement option. Anything else is a gamble about future capital gains tax and future tax rates on 401k/ira withdrawals.
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Gregory · Joined: 20 Feb 2007 Posts: 1554

Gregory · Joined: 20 Feb 2007 Posts: 1554

Tall Grass · Joined: 07 Jul 2008 Posts: 1194 Location: Kansas

Never used munis...never will.
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daryll40 · Joined: 28 Feb 2007 Posts: 1804

Why not?

Gregory · Joined: 20 Feb 2007 Posts: 1554

tfb · Joined: 19 Feb 2007 Posts: 3584

ilan1h · Joined: 22 Oct 2007 Posts: 622

65% of my portfolio was in calif interm munis. I bought them when they were around 11 and followed them down to 9.8. A fairly significant loss over the last year. Last week I decided to tax loss harvest and sold the entire position. Now I find myself strangely unwilling to buy back once the month is up. Somehow, it's erratic behavior has me spooked. I think that the fact that the calif MM muni yield was fluctuating to almost idiotic extremes was particularly scary. Really makes one wonder what is going on.

Qtman · Joined: 29 Jun 2008 Posts: 139 Location: Kent Island, MD

Everyone needs to look at munis for what they want from them. Munis bounce all over on a mark to market daily basis, this will drive some people mad.

I use munis (only GOs and revenue from projects I am familiar with) to provide a steady cash flow that I then take and reinvest in other asset classes. With individual bonds you know held to maturity your principal comes back and with funds you get monthly cash flow for consistency.

Yes there is interest rate risk, which is why until I need the cashflow to live, I reinvest inerest in various equites, more bonds or their equivalent mutual funds with Vanguard.

After tax equivalent yields are looking pretty decent.
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