Top tax bracket in CA - Bonds all muni?

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frankc29
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Top tax bracket in CA - Bonds all muni?

Post by frankc29 » Tue Nov 07, 2017 9:00 pm

Assuming an investor is in the top tax bracket in California and will be for the foreseeable future, does it make sense to have his/her complete bond portion of a portfolio in a CA Muni fund like VCADX? Or should some bond diversification still be present? I'm no expert in this, but VCADX has a higher yield (taxes notwithstanding) than something like BND as it is.

DSInvestor
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Re: Top tax bracket in CA - Bonds all muni?

Post by DSInvestor » Tue Nov 07, 2017 9:06 pm

If you have tax advantaged space like 401(k), 403(b), 457(b), IRA, you can hold taxable bond funds. Use your tax advantaged space for taxable bonds and then complete the bond allocation in taxable accounts with a mix of a national tax exempt bond fund (VWIUX) and your CA tax exempt bond fund. This will give you much better diversification in your bond holdings than just VCADX.

frankc29
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Re: Top tax bracket in CA - Bonds all muni?

Post by frankc29 » Tue Nov 07, 2017 9:08 pm

Thanks for the advice. I forgot to mention that this was a taxable portfolio.

PFInterest
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Re: Top tax bracket in CA - Bonds all muni?

Post by PFInterest » Tue Nov 07, 2017 9:14 pm

I personally vote no. I'll pay a little extra tax to diversify over all 50 states. You could do something like 50:50.

GMT-8
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Re: Top tax bracket in CA - Bonds all muni?

Post by GMT-8 » Tue Nov 07, 2017 9:40 pm

I vote yes. The yield is high; I can still sleep at night.
About 10% of my total portfolio is in Calif Interm & Long Term.
That’s 2/3 of my taxable but I have been spending it down the last few years.

GMT-8

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randomizer
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Re: Top tax bracket in CA - Bonds all muni?

Post by randomizer » Tue Nov 07, 2017 10:22 pm

50 percent state-specific muni, 50 percent short-term tax-exempt (federal). Bonds are for safety, stocks are for growth.

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Noobvestor
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Re: Top tax bracket in CA - Bonds all muni?

Post by Noobvestor » Wed Nov 08, 2017 12:42 am

Let's not forget that if op ends up with long-term gains in this tax-exempt fund that they'll have to pay those to sell.

Meanwhile, from another thread (TL;DR I use national muni funds): viewtopic.php?f=1&t=230543&p=3601487#p3601487
I can't figure out who would want CA tax-exempt over regular tax-exempt. I've considered it but rejected it personally. Consider these four funds and their yields (I'm using Vanguard's SEC yields):

CA intermediate yield: 1.67%
National intermediate yield: 1.74%

CA long yield: 2.14%
National long yield: 2.29%

I plugged in 33% for fed, 10% for state taxes and get tax-equivalent yields as follows:

CA intermediate yield: 2.77%
National intermediate yield: 2.60%

CA long yield: 3.55%
National long yield: 3.42%

But wait - there's more! The CA funds have slightly longer duration and lower-quality holdings. CA intermediate is only 6% AAA and regular intermediate is 23% AAA. There's also state-specific risk. Basically, on a risk-adjusted basis, the CA funds look to me to come out behind.

So you get up to a .17% yield increase for taking on state-specific concentration risk, a bit of duration/quality risk too. Is that really worth it?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

Cyclesafe
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Re: Top tax bracket in CA - Bonds all muni?

Post by Cyclesafe » Wed Nov 08, 2017 11:31 am

In taxable, other than my money market emergency fund, I am 43% VCADX, 57% VWIUX. The latter is 12% non-deductible-for-state-tax Cali bonds, hence the odd allocation. (The net result is 50/50.)

In tax deferred, I am 100% VBTLX.

mega317
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Re: Top tax bracket in CA - Bonds all muni?

Post by mega317 » Wed Nov 08, 2017 11:56 am

Cyclesafe wrote:
Wed Nov 08, 2017 11:31 am
In taxable, other than my money market emergency fund, I am 43% VCADX, 57% VWIUX. The latter is 12% non-deductible-for-state-tax Cali bonds, hence the odd allocation. (The net result is 50/50.)
What is the purpose of doing this math?

ofckrupke
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Re: Top tax bracket in CA - Bonds all muni?

Post by ofckrupke » Wed Nov 08, 2017 12:18 pm

mega317 wrote:
Wed Nov 08, 2017 11:56 am
What is the purpose of doing this math?
Balancing single-state credit risk against the slight after-tax yield advantage of same-state munis.
Cyclesafe prefers to limit CA bonds to 50% of holdings, and has realized that the often suggested 50:50 split between national and CA funds doesn't deliver this, because about 12% of the bonds in the national fund are issued by CA.
By splitting the funds not-quite-equally, the targeted partition of holdings is met.
[eta: I think 47:53 might be the correct ratio though.]

mega317
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Re: Top tax bracket in CA - Bonds all muni?

Post by mega317 » Wed Nov 08, 2017 12:36 pm

Got it. Clever.

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grabiner
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Re: Top tax bracket in CA - Bonds all muni?

Post by grabiner » Fri Nov 10, 2017 11:18 am

frankc29 wrote:
Tue Nov 07, 2017 9:00 pm
Assuming an investor is in the top tax bracket in California and will be for the foreseeable future, does it make sense to have his/her complete bond portion of a portfolio in a CA Muni fund like VCADX? Or should some bond diversification still be present? I'm no expert in this, but VCADX has a higher yield (taxes notwithstanding) than something like BND as it is.
In the top CA tax bracket, you might want to diversify your bonds, but I wouldn't suggest Total Bond Market. You could put half your bonds in a non-CA muni fund; if you put half in Limited-Term Tax-Exempt and half in CA Long-Term Tax-Exempt, you have an intermediate duration with much more than half your bonds exempt from CA tax. Another alternative would be to use TIPS, which are exempt from CA tax but subject to federal tax, and which tend to have low yields because they are low-risk bonds.

You should also buy $10,000 annually in I-Bonds, which are exempt from state tax and defer federal tax until cashed in, but that won't have much effect on your overall allocation if you have the large portfolios which are typical for investors in the top tax bracket.
David Grabiner

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