Vanguard Long-Term Tax-Exempt Fund instead of a CD

[student5]

Hi everyone,

I need some advice. I have a $200,000 primary mortgage at 2.8% fixed for 15 years (another 12 years to go). I have $200,000 that is currently surplus sitting in a 1 year CD that is earning 1.25%. Is it a no-brainer to move that CD into the Vanguard LT Tax-Exempt Fund, Admiral shares (VWLUX) so that I can get a better after-tax return than my mortgage interest rate? My only concern is loss of principal, but I reckon that over 10+ years, the risk of principal loss is much less. Am I thinking correctly? Thanks!

[Call_Me_Op]

Hi everyone,

I need some advice. I have a $200,000 primary mortgage at 2.8% fixed for 15 years (another 12 years to go). I have $200,000 that is currently surplus sitting in a 1 year CD that is earning 1.25%. Is it a no-brainer to move that CD into the Vanguard LT Tax-Exempt Fund, Admiral shares (VWLUX) so that I can get a better after-tax return than my mortgage interest rate? My only concern is loss of principal, but I reckon that over 10+ years, the risk of principal loss is much less. Am I thinking correctly? Thanks!

Why is your goal for this money to do better than your mortgage interest rate?

A LT Tax-Exempt fund is a different animal compared to a 1 year CD. The tax-exempt fund is much riskier. What is the goal for your "surplus" $200k?

[Artsdoctor]

Your question has multiple components:

When is it better to pay off one's mortgage versus investing in fixed income?
How does one decide what average maturity is most beneficial when investing in fixed income?
Is the purpose of one's fixed income investments yield? Total return? To stabilize the volatility of the equity investments?

Without knowing your overall goals, it's difficult to advise.

One thing I will offer is that you might want to compare the long-term fund's projected SEC yield (2.12%) with the intermediate-term fund's projected SEC yield (1.53%). The reported average maturity of the long-term fund is 16 years, whereas the average maturity of the intermediate-term fund is 8.6 years. You can also look at duration to get a measure of volatility (6.4 years versus 4.8 years).

[john94549]

Generally speaking, one gets a boost these days paying off a mortgage. As I recall, mortgage rates hit bottom right around 3.4%. Hard to find anything tax-equivalent in an investment.

[student5]

Thanks everyone. Currently that 200k in the CD is spare cash and is a cushion-not earmarked for any project pro tem.

[dbr]

First decide whether or not it might make sense to pay off the mortgage or part of the mortgage. Personally I think that could be argued either way.

Next look at your overall asset allocation plan including the $200K and put the money out of where it shouldn't be and where it should be. It is unlikely but not impossible that holding national munis in your taxable account would make sense.

If you want more specific advice you probably need to post the complete picture according to: viewtopic.php?f=1&t=6212

[grabiner]

I need some advice. I have a $200,000 primary mortgage at 2.8% fixed for 15 years (another 12 years to go). I have $200,000 that is currently surplus sitting in a 1 year CD that is earning 1.25%. Is it a no-brainer to move that CD into the Vanguard LT Tax-Exempt Fund, Admiral shares (VWLUX) so that I can get a better after-tax return than my mortgage interest rate? My only concern is loss of principal, but I reckon that over 10+ years, the risk of principal loss is much less. Am I thinking correctly? Thanks!

In your situation, this is a good deal, for an interesting reason: your mortgage is a negative bond.

Long-Term Tax-Exempt has interest-rate risk; if rates rise, the fund will lose money. In addition, you can view the individual bonds in the fund as having inflation risk; if you buy $200K worth of ten-year bonds, you will get interest and get the $200K back in ten years, but you don't know what $200K.

But your mortgage works the other way. If interest rates rise, your mortgage is worth less to the bank. If inflation increases, your mortgage costs you less spending power to pay.

So, by holding both bonds and a mortgage, you cancel out the risk. For about $200K, you could buy a bond portfolio which exactly covers your mortgage payments for 12 years, and you would be in the same situation as if you had neither bonds nor a mortgage. Given your low rate, you could probably buy the bond portfolio for a bit less than $200K. And Long-Term Tax-Exempt is close to that bond portfolio; your mortgage has a duration (weighted average time of future payments) of six year.

I am in a similar situation, and have made the same decision. I have 13 years left on my 2.625% mortgage. I don't hold any bonds in my taxable account, but when the market hit bottom in February, I could have sold enough stock to pay off the mortgage with little capital-gains tax (and moved an equal amount from bonds to stock in my retirement plan). But the mortgage is 1.89% after tax in my 28% bracket, and I can earn more than that on muni bond investments. I chose to hold the bonds in my retirement plan and stocks in the taxable account.

[student5]

Yes Grabiner, my thinking too! Thanks!