Bonds Exchange in Taxable Account

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ElecEel
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Joined: Wed Aug 27, 2014 7:49 am

Bonds Exchange in Taxable Account

Postby ElecEel » Mon Mar 20, 2017 7:06 pm

Hey guys,

I have 25% of my portfolio in Vanguard Intermediate Tax Exempt Fund (VWIUX). With interest rates moving up, what are your thoughts in moving it all into Total Bond (VBTLX) or Short Term Corporate Bond (VSCSX) to protect against rising rates. My rationale is that VWIUX bonds are all about 8 years in maturity. VBTLX and VSCSX have shorter durations and won't lose as much in stock price as interest rates climb.

Please share your feedback and suggest alternatives too if I'm way off.

Thanks all.

livesoft
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Re: Bonds Exchange in Taxable Account

Postby livesoft » Mon Mar 20, 2017 7:08 pm

What is your marginal income tax bracket and your state of residence?

Can you put all your bond allocation in a tax-deferred account if you wanted to?
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lack_ey
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Re: Bonds Exchange in Taxable Account

Postby lack_ey » Mon Mar 20, 2017 7:12 pm

Setting aside the idea of market timing based on the same information and assumptions others have, and which rates you're referring to by "rising rates", the muni bond fund has lower effective duration and maturity than the actual average maturity because many of the bonds it owns are callable and likely will be called. It may actually be slightly less rate sensitive than total bond, though a better characterization would probably be "similar." That said, it may be more sensitive if rates rise very dramatically and quickly.

I also don't really understand the rationale for switching from a muni bond fund to taxable bond funds when every fund you mention is from Vanguard, and this fund company you're talking about has shorter-duration muni bond funds. They have Vanguard Limited-Term Tax-Exempt Fund (VMLUX) and Vanguard Short-Term Tax-Exempt Fund (VWSUX), for reference.

ElecEel
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Re: Bonds Exchange in Taxable Account

Postby ElecEel » Mon Mar 20, 2017 7:30 pm

Livesoft - I live in Florida and in the 25% bracket. The company mostly offers Target Funds.

Lack_ey - I didn't know those bonds were callable. That's good to know. I actually saw VMLUX but missed VWSUX. I apologize for not being clear, I'm looking at Vanguard funds only. If you had to choose between VWSUX and VWIUX, do you have a preference?

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ogd
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Re: Bonds Exchange in Taxable Account

Postby ogd » Mon Mar 20, 2017 7:35 pm

ElecEel wrote:Please share your feedback and suggest alternatives too if I'm way off.

You should probably stay put.

Switching from munis to taxable bonds and back should be a decision based solely on tax situation. If you want to shorten duration, you can do it in the muni space, with a Short or Limited fund or a combination.

Now, whether you should shorten duration or not -- the market has its own predictions of interest rates baked into the yield curve, i.e. the difference between longer and shorter bond yields tells us that the market is worried about rates going up less or more. If the market has it about right, it doesn't matter what you choose as it will try to balance the prices/yields of short vs long so they come out about even in a hypothetical scenario. The question is, why do you think that the market is wrong and in which direction? If you know better than people doing this 24/7 with a lot of technological help, have you tried applying this in the stock space where the rewards are immensely greater than the likely 1-5% differences you'll be able to extract by switching durations at the best moment? Various types of stocks too depend on interest rates -- and since we don't try to pick those, we shouldn't try to market time durations either.

indexlover
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Re: Bonds Exchange in Taxable Account

Postby indexlover » Mon Mar 20, 2017 8:29 pm

lack_ey wrote: the muni bond fund has lower effective duration and maturity than the actual average maturity because many of the bonds it owns are callable and likely will be called.


Trying to understand this "callable". I thought bonds are called during declining interest rates not when it is increasing. ( Basing it entirely on Investopedia wiki)

TIA for the explanation.

ElecEel
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Joined: Wed Aug 27, 2014 7:49 am

Re: Bonds Exchange in Taxable Account

Postby ElecEel » Mon Mar 20, 2017 8:41 pm

ogd wrote:Now, whether you should shorten duration or not -- the market has its own predictions of interest rates baked into the yield curve, i.e. the difference between longer and shorter bond yields tells us that the market is worried about rates going up less or more. If the market has it about right, it doesn't matter what you choose as it will try to balance the prices/yields of short vs long so they come out about even in a hypothetical scenario. The question is, why do you think that the market is wrong and in which direction? If you know better than people doing this 24/7 with a lot of technological help, have you tried applying this in the stock space where the rewards are immensely greater than the likely 1-5% differences you'll be able to extract by switching durations at the best moment? Various types of stocks too depend on interest rates -- and since we don't try to pick those, we shouldn't try to market time durations either.


You're absolutely right. I can't compete not do I claim to know more than the SMEs with all their calculators. My thought was based off an article where I read that long term bonds prices are more susceptible to interest rate changes. Again, with very little experience in bonds, or ever investing in bonds, I was leaning to short term to preserve capital.

livesoft
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Re: Bonds Exchange in Taxable Account

Postby livesoft » Mon Mar 20, 2017 8:44 pm

Thanks for answering some of my questions. In your situation, there is no way I would own any bonds in my taxable account.
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indexlover
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Re: Bonds Exchange in Taxable Account

Postby indexlover » Mon Mar 20, 2017 8:52 pm

livesoft wrote: In your situation, there is no way I would own any bonds in my taxable account.


Livesoft,
VWIUX's SEC yield is 2.15%
VBTLX's SEC yield is 2.56%
OP's Tax rate is 25%, if OP has to have bonds ( for AA reasons) in a taxable account, isn't VWIUX better ?

TIA

lack_ey
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Re: Bonds Exchange in Taxable Account

Postby lack_ey » Mon Mar 20, 2017 9:09 pm

indexlover wrote:
lack_ey wrote: the muni bond fund has lower effective duration and maturity than the actual average maturity because many of the bonds it owns are callable and likely will be called.


Trying to understand this "callable". I thought bonds are called during declining interest rates not when it is increasing. ( Basing it entirely on Investopedia wiki)

TIA for the explanation.

First of all, you don't know that rates are going to rise. Short-term likely will and that's what the market expects. Intermediate-term, maybe, but less certain. Could be the yield curve flattens rather than all rising.

In any case, the issuer could have the money ready at the call date and want to call early to stop paying any interest at all. Even if rates rise, they still might be lower than when the bonds were issued in the first place (or potentially, lower for that particular issuer, which may not be the same thing as lower overall), making it advantageous for the issuer to call them and issue new bonds.

The point is that a number of the bonds in the portfolio are varying degrees of likely to be called under a range of potential scenarios, so the average maturity overstates the behavior and what you're likely to actually get.

(Don't forget that in total bond you also have some callable corporate bonds and a whole other range of prepayment and other issues with optionality with respect to the mortgage-backed securities. But a whole lot of total bond is US Treasuries and some other bonds that are not callable and don't get paid back until one fixed maturity.)


indexlover wrote:
livesoft wrote: In your situation, there is no way I would own any bonds in my taxable account.


Livesoft,
VWIUX's SEC yield is 2.15%
VBTLX's SEC yield is 2.56%
OP's Tax rate is 25%, if OP has to have bonds ( for AA reasons) in a taxable account, isn't VWIUX better ?

TIA

Is the risk identical between those?

livesoft
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Re: Bonds Exchange in Taxable Account

Postby livesoft » Mon Mar 20, 2017 9:16 pm

indexlover wrote:OP's Tax rate is 25%, if OP has to have bonds ( for AA reasons) in a taxable account, isn't VWIUX better ?

The enormous amount of bonds in taxable are taking up space that could be used for equities in taxable. I just wouldn't have bonds in taxable in this situation.

To put it another way, the increase of taxes on gains of equities held in the tax-deferred accounts is a much bigger negative than any yield differences that you cited.
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ElecEel
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Re: Bonds Exchange in Taxable Account

Postby ElecEel » Tue Mar 21, 2017 5:11 am

livesoft wrote:
indexlover wrote:OP's Tax rate is 25%, if OP has to have bonds ( for AA reasons) in a taxable account, isn't VWIUX better ?

The enormous amount of bonds in taxable are taking up space that could be used for equities in taxable. I just wouldn't have bonds in taxable in this situation.

To put it another way, the increase of taxes on gains of equities held in the tax-deferred accounts is a much bigger negative than any yield differences that you cited.


Sorry Livesoft, I don't really understand. I thought we could hold municipal bonds in taxable because of tax exemption. Can you show me an example of why this is bad please?

Thanks.

jh-1391
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Re: Bonds Exchange in Taxable Account

Postby jh-1391 » Tue Mar 21, 2017 6:57 am

This is slightly off topic to the OP, but it has to do with bonds, or lack thereof, in a taxable account..

So I operate my accounts (Roth IRA, company 401k, taxable brokerage) with independent asset allocations. What I mean is they all have identical allocations, just different funds based on what's available, with the exception of my taxable since I'm still getting started. It was just too hard for me to balance across multiple accounts and multiple custodians when I had each account being a portion of my overall allocation. I didn't get it. So it's why I'm doing what I'm doing now.

So should I apply a different strategy with my taxable account? Sounds like that answer is yes. But how should I handle capital preservation for re-balancing purposes in my taxable account? I'm holding I Bonds as a part of my EF now, so my overall bond exposure isn't my issue, I just don't understand the best way to preserve the ability to re-balance in an account where I'm likely to be 100% equities. Should I just hold cash for this?


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