Tax efficient bond fund for Taxable account

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SpartanBull
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Joined: Fri Jun 06, 2014 12:31 am

Tax efficient bond fund for Taxable account

Post by SpartanBull »

If I wanted to have a bond fund in my taxable account, but am aware of the negative tax implications of doing so, would one of those municipal bond funds, or "tax exempt" bond funds eliminate this problem completely, and make the bond fund every bit as tax efficient as VTSAX, VTIAX, etc? Is there some type of downside I'm missing? For purposes of this question, lets say that I make $75,000/year. Any suggestions would be greatly appreciated. Thanks!
finite_difference
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Re: Tax efficient bond fund for Taxable account

Post by finite_difference »

You could do a lot worse than Vanguard Total Bond (VBTLX).

Compare it to VWIUX also.
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tooluser
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Re: Tax efficient bond fund for Taxable account

Post by tooluser »

Hard to tell. The relative benefit of municipal bonds depends on your tax bracket. Every time I compare yields between regular and municipal bonds (for example, VBILX vs VWIUX vs VCAIX, various types of Vanguard intermediate term bond funds), it appears to be pretty much a wash for the 28% US federal tax bracket plus 9.3% California state tax bracket, very slightly in favor of tax-exempt bonds. Less than 0.1% extra yield.

So far I have not bothered with tax-exempt - I feel there is a little more risk there, and it has not seemed worth it to me. The payout difference may be magnified if interest rates rise, and that might change the picture.
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Impromptu
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Re: Tax efficient bond fund for Taxable account

Post by Impromptu »

I opened a taxable account in TD Ameritrade recently. I do 3 funds in all of my other types of accounts (works fine if all have relatively low expense ratios), so am using a commission free municipal bond ETF, iShares National Muni bond, MUB, to meet that need. It took some time to decide. I have been in the 33% & 35% tax brackets recently, and the general advice was that municipal bonds started making sense above the 28% tax bracket. My Roth accounts have Vanguards Total Bond Market ETF, BND.
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grabiner
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Re: Tax efficient bond fund for Taxable account

Post by grabiner »

Muni funds avoid taxes (although most states tax munis from other states), but you have an effective tax cost. If a muni fund yields 1.5%, and a taxable bond fund of the same risk level yields 2%, then you are losing 0.5% by holding the muni fund compared to holding the taxable bond fund in your IRA. This is the same cost as holding the taxable bond fund if you are in a 25% bracket.

My guess is that bonds in a taxable account have about the same tax cost as stocks at current yields. If Vanguard has a muni fund for your state, or you are in the top tax bracket (23.8% tax on qualified dividends), then munis in taxable are a better deal at current yields. If bond yields rise, you may want to switch to bonds in tax-deferred, and you can probably do this for a capital loss.
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