Is it ok to have only muni bonds and no taxable bonds?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
gambino
Posts: 2
Joined: Fri Jan 01, 2016 6:23 pm

Is it ok to have only muni bonds and no taxable bonds?

Post by gambino » Sat Dec 31, 2016 2:25 pm

Is it ok to have only muni bond funds and no taxable bonds in the taxable portion of a portfolio? I am specifically looking at the CA long term tax exempt fund.

If you think at least some taxable bonds are needed, what would be a good ratio of total bond to muni bond? 50/50 perhaps?

Marginal tax rates are 33% federal and 9.3 state if you were wondering.

Thanks for sharing your wisdom.

retiredjg
Posts: 30376
Joined: Thu Jan 10, 2008 12:56 pm

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by retiredjg » Sat Dec 31, 2016 3:04 pm

Your question is unclear. Are you asking if it is OK to hold only muni bonds? Or are you asking if it is OK to hold only muni bonds in taxable?

I'm going to answer the first question.

I think it is likely not a good idea to hold all your bond money in muni bonds. Munis are a bit of a different breed and they carry more risk than taxable bonds. I would try to keep munis to less than half of your bond allocation. I would also keep a state muni to half or less of the muni portion of my portfolio.

If your entire portfolio is in a taxable account, I'd spread half out to other fixed income assets - CDs or I Bonds for instance.


If you meant the other question….in your tax bracket, I would only hold munis in taxable, no more than half of that in the CA muni bond fund. I would not hold taxable bonds in taxable, but there are national (not state) muni funds that you can use. Again, there are CDs and I Bonds that can be used for some of your fixed income assets.

User avatar
grabiner
Advisory Board
Posts: 20695
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by grabiner » Sat Dec 31, 2016 4:31 pm

One other type of bond you should consider for your taxable account is I-Bonds. Purchases are limited to $10,000, but the interest is federal tax-deferred and state tax-free.

Putting all your bonds in a single state is somewhat risky. I normally recommend an equal mix of Vanguard Limited-Term Tax-Exempt and Vanguard CA Long-Term Tax-Exempt, so that you have an overall intermediate-term duration and more than half the income is exempt from CA tax.
David Grabiner

User avatar
dratkinson
Posts: 3958
Joined: Thu Jul 26, 2007 6:23 pm
Location: Centennial CO

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by dratkinson » Sun Jan 01, 2017 3:40 pm

"Is it ok to have only muni bonds and no taxable bonds?" That's my plan as I "shoot for the moon" in my small orphaned tax-advantaged space. My bond target is 50/50 national/single-state munis. I could be wrong.


A safer course is to also have some taxable bonds in tax-advantaged space (mixed with munis in your taxable space). But if you use a target date retirement fund in your tax-advantaged space (401k, IRA,...), then the taxable bonds are being taken care of for you.

Taxable bonds in taxable space in a high tax bracket is not recommended.
See: https://www.bogleheads.org/wiki/Princip ... _Placement
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

KernelSanders
Posts: 21
Joined: Fri Dec 23, 2016 4:35 pm
Location: MO

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by KernelSanders » Sun Jan 01, 2017 5:11 pm

I have been looking into this as well as I am just a little order (32), in a similar tax situation (bit more federal but little less state) and most of my new investing is going into a taxable account.

I have not found a state muni bond fund for MO (my state), but I have seen the maximum of a 50% ratio of state to national muni bonds recommended pretty consistently.

In my research, there doesn't seem to be a consensus on how large of a portion munis should make up of your overall bond portfolio. Generally, I have been looking at the total market indexes to determine an allocation band for sector funds, but munis aren't included in Total Bond Market because of the different tax treatment. The most recent data I could find shows municipal bonds make up about 10% of the total US bond market.

I have also been looking into I and EE savings bonds. Both offer tax deferred interest which appeals to me because I am short on tax-advantaged space. In my opinion, we are both probably a bit too young for the exactly 20 years optimal holding period for EE bonds, but I am strongly considering getting some I bonds. You need to hold for a minimum of one year and pay a 3-months interest penalty for redemption in the first 5 years, but they offer up to 30 years of federal tax deferred and state/local tax free growth.

I have about 15% of my overall bond portfolio in the Vanguard Intermediate-Term Tax-Exempt Fund right now, but will probably put the next 15% into I bonds. I am also setting up a ladder of recurring purchases to start moving some of my emergency fund to I bonds in 2018. I will probably run up against the $10k per year individual limit, but I am married so I can purchase under my wife's tax id as well. There is also the option to purchase up to an additional $5k if you have a federal tax refund.

brad.clarkston
Posts: 451
Joined: Fri Jan 03, 2014 8:31 pm
Location: Kansas City, MO

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by brad.clarkston » Sun Jan 01, 2017 5:21 pm

I'm in MO (Kansas City) as well and our muni's all suck pretty badly.

Huge loads (4-5%) and high ER's (0.70's) coupled with low trade amounts.

http://bondfunds.com/category/municipal/missouri/

I can't even get the First American ones to pull up in FID.

~~

I'm looking at I-Bonds (treasurydirect.gov) and TIPS (FID secondary market) myself.

User avatar
grabiner
Advisory Board
Posts: 20695
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by grabiner » Sun Jan 01, 2017 6:49 pm

brad.clarkston wrote:I'm in MO (Kansas City) as well and our muni's all suck pretty badly.

Huge loads (4-5%) and high ER's (0.70's) coupled with low trade amounts.

http://bondfunds.com/category/municipal/missouri/

I can't even get the First American ones to pull up in FID.


At those rates, it isn't worth using a state muni fund; you'll lose more in expenses than you save in taxes. If you hold bonds in your taxable account, you can use a national muni fund, or, depending on your tax bracket, use bonds which are exempt from state but not federal tax:
I'm looking at I-Bonds (treasurydirect.gov) and TIPS (FID secondary market) myself.


I-Bonds are good in almost any bracket, and TIPS in taxable are good in most tax brackets. (Note that if you hold individual TIPS, you have to pay tax on the inflation adjustment even though you don't receive it in cash; if you hold a TIPS fund, the inflation adjustment is paid out as part of the dividend.)
David Grabiner

SleepKing
Posts: 232
Joined: Mon Mar 02, 2015 8:45 am

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by SleepKing » Sun Jan 01, 2017 7:04 pm

It sounds like you are only asking about taxable accounts. Like others have implied, the answer depends:

-If you have absolutely no other bond holdings, such as shorter term federal bond fund in a tax advantaged account, then too risky. I'd consider a split of Van CA Muni and Federal tax exempt (or something similar) to add diversification.

-If you have other bond holdings that add diversity, then yes; it would be reasonable to hold the long term CA muni as your only bond position in your taxable account.

If it helps, our bond position is 90% in tax advantaged space where we utilize VBTLX (tot bond) and 10% in our state long term muni fund. The muni fund is our entire taxable bond position.

inception
Posts: 4
Joined: Thu Dec 01, 2016 4:32 am

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by inception » Sun Jan 01, 2017 7:23 pm

gambino wrote:Is it ok to have only muni bond funds and no taxable bonds in the taxable portion of a portfolio? I am specifically looking at the CA long term tax exempt fund.

If you think at least some taxable bonds are needed, what would be a good ratio of total bond to muni bond? 50/50 perhaps?

Marginal tax rates are 33% federal and 9.3 state if you were wondering.

Thanks for sharing your wisdom.


Personally, I think it would be preferable to invest in a muni bond fund that's diversified across multiple states to reduce the impact of CA-specific risk. With such a fund, you'll already be realizing at least 78% of the tax benefits relative to a CA-only muni fund (i.e., excluding 33% federal tax but most likely still incurring state tax on all of it, assuming the percentage of CA munis in the bond fund isn't unusually large). If you're still concerned about a black swan type of event that simultaneously impacts the muni default rates of multiple states, you could allocate a portion of your bond allocation to US bonds purchased directly from TreasuryDirect (subject to federal tax, but not state tax).

CFM300
Posts: 1226
Joined: Sat Oct 27, 2007 5:13 am

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by CFM300 » Sun Jan 01, 2017 8:22 pm

grabiner wrote:I-Bonds are good in almost any bracket, and TIPS in taxable are good in most tax brackets.

Suppose that all of your bond holdings had to be in taxable (for whatever reason, just take it as an assumption) and that you live in California.

What would you recommend?

25% Vanguard Limited-Term Tax-Exempt
25% Vanguard CA Long-Term Tax-Exempt
and
50% ... ?

User avatar
grabiner
Advisory Board
Posts: 20695
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by grabiner » Sun Jan 01, 2017 8:26 pm

CFM300 wrote:
grabiner wrote:I-Bonds are good in almost any bracket, and TIPS in taxable are good in most tax brackets.

Suppose that all of your bond holdings had to be in taxable (for whatever reason, just take it as an assumption) and that you live in California.

What would you recommend?

25% Vanguard Limited-Term Tax-Exempt
25% Vanguard CA Long-Term Tax-Exempt
and
50% ... ?


Definitely use I-Bonds to the limit; these are the best bonds in taxable because of tax deferral. If you need more bonds, I would recommend TIPS. (And if you have a Health Savings Account, hold TIPS there; California taxes HSAs, but TIPS are exempt from CA tax.)

If you are in the top tax bracket, going all-muni makes more sense, as you would pay 43.4% federal tax on TIPS.
David Grabiner

CFM300
Posts: 1226
Joined: Sat Oct 27, 2007 5:13 am

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by CFM300 » Sun Jan 01, 2017 8:36 pm

grabiner wrote:Definitely use I-Bonds to the limit; these are the best bonds in taxable because of tax deferral. If you need more bonds, I would recommend TIPS. (And if you have a Health Savings Account, hold TIPS there; California taxes HSAs, but TIPS are exempt from CA tax.)

If you are in the top tax bracket, going all-muni makes more sense, as you would pay 43.4% federal tax on TIPS.

Thank you.

My actual situation is that 46% of my bonds are in various tax-sheltered accounts. No HSA yet.

Would you allocate that 46% to Total Bond? So...

25% Vanguard Limited-Term Tax-Exempt (taxable account)
25% Vanguard CA Long-Term Tax-Exempt (taxable account)
04% I-bonds
46% Total Bond (tax-sheltered accounts)

User avatar
grabiner
Advisory Board
Posts: 20695
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by grabiner » Sun Jan 01, 2017 10:49 pm

CFM300 wrote:
grabiner wrote:Definitely use I-Bonds to the limit; these are the best bonds in taxable because of tax deferral. If you need more bonds, I would recommend TIPS. (And if you have a Health Savings Account, hold TIPS there; California taxes HSAs, but TIPS are exempt from CA tax.)

If you are in the top tax bracket, going all-muni makes more sense, as you would pay 43.4% federal tax on TIPS.

Thank you.

My actual situation is that 46% of my bonds are in various tax-sheltered accounts. No HSA yet.

Would you allocate that 46% to Total Bond? So...

25% Vanguard Limited-Term Tax-Exempt (taxable account)
25% Vanguard CA Long-Term Tax-Exempt (taxable account)
04% I-bonds
46% Total Bond (tax-sheltered accounts)


This looks reasonable, although I would probably max out on I-Bonds in preference to the national munis.
David Grabiner

CFM300
Posts: 1226
Joined: Sat Oct 27, 2007 5:13 am

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by CFM300 » Mon Jan 02, 2017 1:31 am

grabiner wrote:This looks reasonable, although I would probably max out on I-Bonds in preference to the national munis.

Thanks. I currently have no I-Bonds, so will have to build that up over time.

AlohaJoe
Posts: 2429
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by AlohaJoe » Mon Jan 02, 2017 1:43 am

Yes, it is okay to only have municipal bonds and no nominal Treasuries.

Even during the Great Depression defaults were rare. And defaults aren't the end of the story: the recovery rate is almost 100% for general obligation bonds.

The credit risk difference between Treasuries and municipal bonds is dwarfed by interest rate and inflation risk of nominal bonds.

KernelSanders
Posts: 21
Joined: Fri Dec 23, 2016 4:35 pm
Location: MO

Re: Is it ok to have only muni bonds and no taxable bonds?

Post by KernelSanders » Mon Jan 02, 2017 3:51 am

grabiner wrote:This looks reasonable, although I would probably max out on I-Bonds in preference to the national munis.


This is basically my plan for taxable bonds for the immediate future so it is reassuring to get confirmation of my understanding.

A few more thoughts I have had as I consider my options:

1) Agree with maxing I bonds before investing more in munis when you have sizable taxable holdings, but would probably still reach for munis first in taxable because of the limited liquidity of I bonds. If I need to reduce my taxable bond holdings when rebalancing or taking advantage of newly opened tax-advantaged space, I don't want to pay the interest rate penalty and worse force myself to redeem at an inopportune time taxwise.

2) One possible workaround for the previous issue if you've held your I bonds for at least a year is to use a portion of your EF to "buy" I bonds from yourself and use the cash for reinvestment. The current I bond rate of 2.76% and early redemption penalty compares favorably to the CD rates I have seen and also has the benefit of being state and local tax-free. I have not redeemed bonds on the TreasuryDirect site personally, but other posters on this site say the money is in their bank account within 2-3 business days.

3) As a younger investor with a time horizon of 25+ years, I am not sure how much to value the inflation/deflation protection since I expect my stock indexes to provide inflation protection over the long term. Also other posters have mentioned the volatility of TIPS during the 2008 crisis. I bonds still had fixed rates over 1% at that time which provided them some cushion, but with today's 0% fixed rate they seem likely to experience similar volatility issues.

4) I also think the caveats for I bonds on the wiki could be improved. First of all, the illustration is very out of date as it uses a 1% fixed rate and attempts to show the after-tax, after-inflation value of the bonds. Newly issued I bonds have a 0% fixed rate, so I already know that I am going to get at best a 0% real return before taxes and muni bonds are offering even lower real returns.

I think that the advice for investors in their 20s may be lacking some context. As this thread has demonstrated, many younger investors considering I bonds are already in a high tax bracket and have used all of their tax-advantaged space for bonds. As someone in that situation, it seems much more likely to me that I will be in a lower tax bracket at some point in the next 5-30 years (e.g. start my own business and defer all my income in a solo 401k or tax legislation changes) than it is for me to be in a very high tax bracket for all of those years. It also ignores the option of tax-free redemption for qualified education expenses (i.e. anyone who plans to fund a 529 in the next 30 years) which probably applies to many people in their 20s.

Post Reply