Tax-exempt fund duration for the all taxable portfolio

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Murray Boyd
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Tax-exempt fund duration for the all taxable portfolio

Post by Murray Boyd » Mon Dec 03, 2012 4:12 pm

If I remember correctly the conventional wisdom for tax-exempt bonds used to be 50% limited-term, 50% intermediate-term (assuming an all-taxable portfolio). Is that still the case?

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jjunk
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by jjunk » Mon Dec 03, 2012 5:05 pm

I am roughly 35% Limited Term, 65% Intermediate Term in my taxable portfolio but I think 50/50 would be fine.

Sidney
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by Sidney » Mon Dec 03, 2012 5:14 pm

I don't think there is a conventional wisdom. Pick a duration that meets your goals and go for it.
I always wanted to be a procrastinator.

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Noobvestor
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by Noobvestor » Mon Dec 03, 2012 5:18 pm

I'm struggling a bit with this right now. The tax-equivalent yield on the intermediate fund (5-year duration) is about 2%. The tax-equivalent yield on the long fund (6-year duration) is 3%. So for going up 20% in duration, you go up 50% in tax-equivalent yield. Limited term (2.5 year duration), meanwhile, is around 1%.

Now, these funds have slightly different compositions in terms of grades, but not radically different. 1% seems too little compensation for being anywhere on the yield curve and 2% seems a bit silly when you can go out one more year and get 3%.

I'm not much for market timing in general, but the shorter options don't appeal much to me (you can get a 1% yield on a 3-year CD, anyway). I'm personally split currently between intermediate, long and cash, but if it weren't for cap gains on the intermediate fund, I would be inclined to barbell cash and long given current yields. If I were just getting in, I would be very reluctant to go with the limited and/or intermediate options.
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ahndrostalgan
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by ahndrostalgan » Mon Dec 03, 2012 6:25 pm

I faced this decision, and after reading tons of various posts on the subject just took the Lazy way out and invested 100% in intermediate term tax-exempt. Given that my time horizon is considerably greater than the duration of this fund (or Long-term fund), the hassle just didn't seem worth it; presumably the point of dividing between Limited and Intermediate is to better protect the principal, but if your investment horizon is longer than the duration then it seems unnecessary.

Cash
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by Cash » Mon Dec 03, 2012 6:43 pm

I am also about to jump into munis and have been debating intermediate v. long. My time horizon is 30+ years, so I am leaning heavily toward long for the reasons stated by Noobvestor.

ResNullius
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by ResNullius » Mon Dec 03, 2012 6:46 pm

ahndrostalgan wrote:I faced this decision, and after reading tons of various posts on the subject just took the Lazy way out and invested 100% in intermediate term tax-exempt. Given that my time horizon is considerably greater than the duration of this fund (or Long-term fund), the hassle just didn't seem worth it; presumably the point of dividing between Limited and Intermediate is to better protect the principal, but if your investment horizon is longer than the duration then it seems unnecessary.
Yes, but unless I'm missing something, the duration of a bond mutual fund is continually extending out to the length of it's overall duration. There isn't really an endpoint at which you can say that your initially invested principal has been returned in full, along with the yield.

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Rainier
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by Rainier » Mon Dec 03, 2012 6:50 pm

I'm also doing 1/3 cash, 1/3 int term munis, 1/3 long munis. I can't justify the limited term muni fund when I'm better off after tax with 95bps at Ally. Not the case for everyone though.

ahndrostalgan
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by ahndrostalgan » Tue Dec 04, 2012 8:23 am

ResNullius wrote:
ahndrostalgan wrote:I faced this decision, and after reading tons of various posts on the subject just took the Lazy way out and invested 100% in intermediate term tax-exempt. Given that my time horizon is considerably greater than the duration of this fund (or Long-term fund), the hassle just didn't seem worth it; presumably the point of dividing between Limited and Intermediate is to better protect the principal, but if your investment horizon is longer than the duration then it seems unnecessary.
Yes, but unless I'm missing something, the duration of a bond mutual fund is continually extending out to the length of it's overall duration. There isn't really an endpoint at which you can say that your initially invested principal has been returned in full, along with the yield.
My thought--correct or incorrect--was that if you had a 10+ year investment horizon, in my case 20+ years, then sweating over relative durations of 2.5 vs 5.0 vs 6.2 (approximately) seems unnecessary if you are not going to need the money in the longest of those durations doubled. Now, I would agree that as you move towards a shorter time horizon then the nature of mutual bond funds mandates caution and perhaps "tightening up" the duration of the funds being used. I was also giving some weight to the relative ease in using just one fund, whereas committed slice-and-dicers may find using more funds not a problem.

rkhusky
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by rkhusky » Tue Dec 04, 2012 9:02 am

ResNullius wrote:
ahndrostalgan wrote:I faced this decision, and after reading tons of various posts on the subject just took the Lazy way out and invested 100% in intermediate term tax-exempt. Given that my time horizon is considerably greater than the duration of this fund (or Long-term fund), the hassle just didn't seem worth it; presumably the point of dividing between Limited and Intermediate is to better protect the principal, but if your investment horizon is longer than the duration then it seems unnecessary.
Yes, but unless I'm missing something, the duration of a bond mutual fund is continually extending out to the length of it's overall duration. There isn't really an endpoint at which you can say that your initially invested principal has been returned in full, along with the yield.
I thought the reason for having the duration less than your time horizon, was that if interest rates spike, the bond fund will lose principal, and you don't want to have to sell shares until the price has reached equilibrium, which would occur around the time duration of the bonds.

rkhusky
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by rkhusky » Tue Dec 04, 2012 9:09 am

Murray Boyd wrote:If I remember correctly the conventional wisdom for tax-exempt bonds used to be 50% limited-term, 50% intermediate-term (assuming an all-taxable portfolio). Is that still the case?
Another option would be to look at the High Yield Tax Exempt fund. The quality is slightly lower than Intermediate and duration a bit higher.

dbr
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Re: Tax-exempt fund duration for the all taxable portfolio

Post by dbr » Tue Dec 04, 2012 9:52 am

Murray Boyd wrote:If I remember correctly the conventional wisdom for tax-exempt bonds used to be 50% limited-term, 50% intermediate-term (assuming an all-taxable portfolio). Is that still the case?

No, there is no such conventional wisdom. As pointed out,m it is a case of deciding on an appropriate average duration based on judgement of one's own circumstances.

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