Bonds vs Muni Bonds in Taxable

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bulldog1
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Bonds vs Muni Bonds in Taxable

Post by bulldog1 »

Hello All,

I currently hold Vanguard Intermediate-Term Tax-Exempt Bonds in my Vanguard Mutual Fund account. My marginal tax rate is 25%. My effective tax rate has been between 10% to 12% the past 7 years. Since my effective tax rate is low, would it make sense for me to hold Vanguard Total Bond Market Admiral in Taxable? Other reasons for me hold TBM would be less risk and it's half the cost.

Thank you in advance for your suggestions.
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abuss368
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

I think that is an excellent fund - Intermediate Tax Exempt. I have watched and read many interviews where our mentor Jack Bogle notes he invests in the very same fund in his taxable account.

I would stay the course.
John C. Bogle: “Simplicity is the master key to financial success."
jdilla1107
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Re: Bonds vs Muni Bonds in Taxable

Post by jdilla1107 »

The bond income would be taxed at your highest marginal rate, so I'm not sure where you are going with the effective rate thinking.

Also, you should play with something like TurboTax or TaxCaster to see what your real marginal tax rate is. Various credit phase outs can make it more than 25%.
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Re: Bonds vs Muni Bonds in Taxable

Post by grabiner »

Total Bond Market Index is less risky, but you pay for the decreased risk in decreased yield. If you have Admiral shares of Total Bond Market but not Intermediate-Term Tax-Exempt, you earn 1.66% after-tax on Total Bond Market (in your 25% bracket) and 2.15% on Intermediate-Term Tax-Exempt; if you get up to $50K, you will earn 2.23% on Intermediate-Term Tax-Exempt.

That doesn't make the muni fund inherently better; it's just a difference you have to recognize. Intermediate-Term Investment-Grade, at 2.75% pre-tax, 2.06% after tax (2.85% and 2.14% with Admiral shares) is closer in risk level. You could also use Intermediate-Term Bond Index, at 2.68% pre-tax, 2.01% after-tax; this fund has some Treasuries but a longer duration than the all-corporate Intermediate-Term Investment-Grade. Or you could choose to use Total Bond Market, taking the reduced risk and return, or choosing to hold a bit less in bonds to keep the same risk level.

My rule of thumb is that 25% is about the break-even point between munis and taxable bonds of comparable risk. If you are in the phase-out of some tax provision that does not take muni income into account, the muni fund is probably better. Otherwise, at least while you are between the Admiral levels, a taxable fund gives you an extra 0.1% in lower expenses for free, which makes it look better.
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bulldog1
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Re: Bonds vs Muni Bonds in Taxable

Post by bulldog1 »

Thanks you for the responses so far. I am close to getting the admiral shares version of the intermediate-term tax-exempt bond fund. Based on the information and feedback you all provided, I will stay the course.
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

bulldog1 wrote:Thanks you for the responses so far. I am close to getting the admiral shares version of the intermediate-term tax-exempt bond fund. Based on the information and feedback you all provided, I will stay the course.
Do you have any other bond funds? If so what accounts are they located in?
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bulldog1
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Re: Bonds vs Muni Bonds in Taxable

Post by bulldog1 »

abuss368 wrote:
Do you have any other bond funds? If so what accounts are they located in?
I have Target Retirement funds in our 401k, 403b and Roth IRA's. It would have been perfect if my 401k had the VG Target Retirement Fund. We max out all of our retirement accounts. Left over money gets sent to taxable.


His Roth IRA at Vanguard
------------------------
Vanguard Target Retirement 2035 Fund Investor Shares

Her Roth IRA at Vanguard
------------------------
Vanguard Target Retirement 2035 Fund Investor Shares

Her 403(b) at ING
-----------------
Vanguard Target Retirement 2035 Fund Investor Shares

His 401(K) at Fidelity
----------------------
Fidelity Freedom Index 2035 Fund Class W

Taxable at Vanguard
-------------------
Vanguard Total Stock Market Index Fund Admiral Shares
Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares
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abuss368
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

bulldog1 wrote:
abuss368 wrote:
Do you have any other bond funds? If so what accounts are they located in?
I have Target Retirement funds in our 401k, 403b and Roth IRA's. It would have been perfect if my 401k had the VG Target Retirement Fund. We max out all of our retirement accounts. Left over money gets sent to taxable.


His Roth IRA at Vanguard
------------------------
Vanguard Target Retirement 2035 Fund Investor Shares

Her Roth IRA at Vanguard
------------------------
Vanguard Target Retirement 2035 Fund Investor Shares

Her 403(b) at ING
-----------------
Vanguard Target Retirement 2035 Fund Investor Shares

His 401(K) at Fidelity
----------------------
Fidelity Freedom Index 2035 Fund Class W

Taxable at Vanguard
-------------------
Vanguard Total Stock Market Index Fund Admiral Shares
Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares
Jack Bogle has said "simplicity is the master key to financial success."
John C. Bogle: “Simplicity is the master key to financial success."
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abuss368
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

I have wondered if an investor had a high percentage of the total portfolio in a taxable account rather than tax advantaged, and selected a tax exempt bond fund such as Intermediate Term Tax Exempt, would that be more risky than Total Bond. At the end of the day, I would expect that the fund selection is an investor preference and whatever allows one to sleep well at night.

Then I remember numerous Jack Bogle interviews where he notes that his taxable accounts are invested in two bond funds: Intermediate Term Tax Exempt and Limited Term Tax Exempt.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Bonds vs Muni Bonds in Taxable

Post by dbr »

abuss368 wrote:I have wondered if an investor had a high percentage of the total portfolio in a taxable account rather than tax advantaged, and selected a tax exempt bond fund such as Intermediate Term Tax Exempt, would that be more risky than Total Bond. At the end of the day, I would expect that the fund selection is an investor preference and whatever allows one to sleep well at night.

Then I remember numerous Jack Bogle interviews where he notes that his taxable accounts are invested in two bond funds: Intermediate Term Tax Exempt and Limited Term Tax Exempt.
I think I remember a comment of Larry Swedroe's that in general a diversified collection of munis would be more risky at the same duration than Treasuries and less risky than corporates. If total bond has bonds both less risky and more risky than munis, I am not sure how that answer comes out. All of this must be normalized on duration, of course.

Someone else may have a better answer.
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

dbr wrote:
abuss368 wrote:I have wondered if an investor had a high percentage of the total portfolio in a taxable account rather than tax advantaged, and selected a tax exempt bond fund such as Intermediate Term Tax Exempt, would that be more risky than Total Bond. At the end of the day, I would expect that the fund selection is an investor preference and whatever allows one to sleep well at night.

Then I remember numerous Jack Bogle interviews where he notes that his taxable accounts are invested in two bond funds: Intermediate Term Tax Exempt and Limited Term Tax Exempt.
I think I remember a comment of Larry Swedroe's that in general a diversified collection of munis would be more risky at the same duration than Treasuries and less risky than corporates. If total bond has bonds both less risky and more risky than munis, I am not sure how that answer comes out. All of this must be normalized on duration, of course.

Someone else may have a better answer.
That was a good post and makes a lot of sense. At the end of the day, the municipalities have taxing authority. This is much different than corporations.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Bonds vs Muni Bonds in Taxable

Post by Call_Me_Op »

abuss368 wrote: At the end of the day, the municipalities have taxing authority. This is much different than corporations.
They do have taxing authority, but do not have a statutory obligation to pay their debts. That's what makes treasuries safer than muni's.
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Re: Bonds vs Muni Bonds in Taxable

Post by ogd »

bulldog1 wrote:My marginal tax rate is 25%. My effective tax rate has been between 10% to 12% the past 7 years. Since my effective tax rate is low, would it make sense for me to hold Vanguard Total Bond Market Admiral in Taxable?
You should always look at the marginal rate when considering the impact of an investment. If you switched to Total Bond Market, each additional dollar of fund income would give you only 75 cents of after-tax income.

Like grabiner, my gut feeling is that the cutoff point for municipal bonds becoming a better deal is in the 25-28% range. What matters here is how many bond holders with taxable bond investments are below vs above that range, and thus whether muni bond prices are overstated by less than 25% or by more. This is not an easy question to answer precisely.
dbr wrote:I think I remember a comment of Larry Swedroe's that in general a diversified collection of munis would be more risky at the same duration than Treasuries and less risky than corporates. If total bond has bonds both less risky and more risky than munis, I am not sure how that answer comes out. All of this must be normalized on duration, of course.
Total Bond held up better than munis in 2008. It contains so many government backed bonds that the riskiness of corporate bonds is muted. In addition, there were times like late 2010 when munis had an idiosyncratic mini-crash due to rumors of defaults, and they remain vulnerable to losing their tax advantaged status and rumors thereof, however unlikely.

I love munis but I'd be uncomfortable having more than 1/3 to 1/2 of my bond holdings in them.
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bulldog1
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Re: Bonds vs Muni Bonds in Taxable

Post by bulldog1 »

abuss368 wrote:

Then I remember numerous Jack Bogle interviews where he notes that his taxable accounts are invested in two bond funds: Intermediate Term Tax Exempt and Limited Term Tax Exempt.
I researched your comment about Jack holding the Intermediate Term tax Exempt and I did find an interview where he states that he holds this fund. Good to know. =)

In the beginning when I was planning the funds for my taxable account, I considered Tax-Managed Balanced for even more simplicity. I decided to go with TSM and Intermediate-Term Tax-Exempt for more control of my AA. I feel I still have accomplished simplicity.
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

bulldog1 wrote:
abuss368 wrote:

Then I remember numerous Jack Bogle interviews where he notes that his taxable accounts are invested in two bond funds: Intermediate Term Tax Exempt and Limited Term Tax Exempt.
I researched your comment about Jack holding the Intermediate Term tax Exempt and I did find an interview where he states that he holds this fund. Good to know. =)

In the beginning when I was planning the funds for my taxable account, I considered Tax-Managed Balanced for even more simplicity. I decided to go with TSM and Intermediate-Term Tax-Exempt for more control of my AA. I feel I still have accomplished simplicity.
Jack Bogle has recommended a simple two fund portfolio consisting of Total Stock Market and Total Bond Market. I am sure Intermediate Term Tax Exempt can be substituted for Total Bond Market in a taxable account.

You have a nice portfolio. Now stay the course.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Bonds vs Muni Bonds in Taxable

Post by btenny »

I use a lot of Intermed Term Muni in my taxable accounts as gov't backed securities instead of Treasuries as they are not munipulated as much IMO. I also hold 2-3 years of spending money in Short Term Munis in my taxable as well. Then I hold Intermediate Corporates and TIPS in my IRA tax free accounts. I also hold short term corporates for emergency spending in my IRA as I am retired and do not want to take a big interest rate risk. This mix along with 40% or so stocks in both accounts give me a OK return and a smooth balanced ride.

I do this as I am not a fan of Total Bond Market with its big slug of Treasuries and Fannie and Freddie stuff...
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Re: Bonds vs Muni Bonds in Taxable

Post by abuss368 »

btenny wrote:I use a lot of Intermed Term Muni in my taxable accounts as gov't backed securities instead of Treasuries as they are not munipulated as much IMO. I also hold 2-3 years of spending money in Short Term Munis in my taxable as well. Then I hold Intermediate Corporates and TIPS in my IRA tax free accounts. I also hold short term corporates for emergency spending in my IRA as I am retired and do not want to take a big interest rate risk. This mix along with 40% or so stocks in both accounts give me a OK return and a smooth balanced ride.

I do this as I am not a fan of Total Bond Market with its big slug of Treasuries and Fannie and Freddie stuff...
I understand your strategy. I have one question: You had mentioned Treasuries are possibly manipulated. You also hold TIPS. TIPS are a form of Treasury bonds. Could you please explain in more detail?

Thanks.
John C. Bogle: “Simplicity is the master key to financial success."
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