Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

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Sandtrap
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Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sat Jan 13, 2018 9:36 pm

I am rebalancing and redeploying substantial funds into my portfolio that will put me into the 32% tax bracket.
All Taxable Space.

What I have now:
Formerly Vanguard Total Bond Admiral (VBTLX) 100%

Propose going 50/50 in Bond allocation with:

50% Vanguard Total Bond Admiral (VBTLX)
and
50% Vanguard Inter-Term Tax Exempt (VWIUX)

I will not have to sell equities or existing Total Bond VBTLX to do this.
It would be done simply with the addition of new cash.

1 Will it make much difference in my tax liabilities?
2 Should I go to a higher percentage VWIUX?
3 Would I be cutting yield and better off sticking with Total Bond and paying the taxes?
Thoughts?
Suggestions?

Thanks everyone for your kind and continuing help.
mahalo,
j :D
Last edited by Sandtrap on Sat Jan 13, 2018 11:30 pm, edited 1 time in total.

sambb
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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by sambb » Sat Jan 13, 2018 9:39 pm

go all to tax exempt

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sun Jan 14, 2018 11:56 am

sambb wrote:
Sat Jan 13, 2018 9:39 pm
go all to tax exempt
Thanks.
Why all in and not a percentage of?
Is VWIUX (vanguard tax exempt int term) a good alternative??. I have read past threads.
j :D

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by grabiner » Sun Jan 14, 2018 2:54 pm

My rule of thumb is that 25% is the break-even for taxable versus tax-exempt bonds; that is, bonds of comparable risk will have comparable returns at a 25% tax rate. At a 32% tax rate, you can get higher returns for the same level of risk, or lower risk for the same return, so you should use all munis if you hold bonds in your taxable account.

Vanguard Intermediate-Term Tax-Exempt tends to be the default recommendation of Bogleheads, because it is similar in risk to Total Bond Market and thus fills the same role in your portfolio.

Does Vanguard have a fund for your state? If so, you could consider putting half your bonds in that state's long-term fund, and half in Limited-Term Tax-Exempt, for an overall intermediate duration with better diversification than putting everything in your state, and more than half of your income exempt from state tax.
Wiki David Grabiner

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sun Jan 14, 2018 3:22 pm

grabiner wrote:
Sun Jan 14, 2018 2:54 pm
My rule of thumb is that 25% is the break-even for taxable versus tax-exempt bonds; that is, bonds of comparable risk will have comparable returns at a 25% tax rate. At a 32% tax rate, you can get higher returns for the same level of risk, or lower risk for the same return, so you should use all munis if you hold bonds in your taxable account.

Vanguard Intermediate-Term Tax-Exempt tends to be the default recommendation of Bogleheads, because it is similar in risk to Total Bond Market and thus fills the same role in your portfolio.

Does Vanguard have a fund for your state? If so, you could consider putting half your bonds in that state's long-term fund, and half in Limited-Term Tax-Exempt, for an overall intermediate duration with better diversification than putting everything in your state, and more than half of your income exempt from state tax.
Thanks "David", I was hoping you would chime in.
Vanguard doesn't have anything for Arizona. Shucks.

This is their list:
Vanguard California Tax-Exempt Money Market Fund
Vanguard California Intermediate-Term Tax-Exempt Fund
Vanguard California Long-Term Tax-Exempt Fund Vanguard Massachusetts Tax-Exempt Fund
Vanguard New Jersey Tax-Exempt Money Market Fund
Vanguard New Jersey Long-Term Tax-Exempt Fund
Vanguard New York Tax-Exempt Money Market Fund
Vanguard New York Long-Term Tax-Exempt Fund
Vanguard Ohio Tax-Exempt Money Market Fund
Vanguard Ohio Long-Term Tax-Exempt Fund
Vanguard Pennsylvania Tax-Exempt Money Market Fund
Vanguard Pennsylvania Long-Term Tax-Exempt Fund

So I guess my best alternative is the VWIUX, int term tax exempt fund?
Does it matter much if I have 50% Total Bond VBTLX Admiral and 50% VWIUX Int Term Tax Exempt Admiral
or 100% VWIUX tax exempt int term admiral?

Mahalo,
j :D

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by randomizer » Sun Jan 14, 2018 3:25 pm

In this situation in the past I went to 50% short-term tax exempt, 50% state-specific muni (because I had one in my state).

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by grabiner » Sun Jan 14, 2018 4:28 pm

Sandtrap wrote:
Sun Jan 14, 2018 3:22 pm
Vanguard doesn't have anything for Arizona. Shucks.

So I guess my best alternative is the VWIUX, int term tax exempt fund?
Does it matter much if I have 50% Total Bond VBTLX Admiral and 50% VWIUX Int Term Tax Exempt Admiral
or 100% VWIUX tax exempt int term admiral?
I would prefer 100% munis in your tax bracket, given the tax cost. If you hold bonds in your IRA/401(k), they could be in Total Bond Market.
Wiki David Grabiner

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by UpperNwGuy » Sun Jan 14, 2018 6:26 pm

Sandtrap wrote:
Sun Jan 14, 2018 3:22 pm
Does it matter much if I have 50% Total Bond VBTLX Admiral and 50% VWIUX Int Term Tax Exempt Admiral
or 100% VWIUX tax exempt int term admiral?
This is my plan, but I'm in the break-even 25% (now 24%) tax bracket. It is my understanding that these two funds have no overlap whatsoever, so I like the diversification that the 50/50 split provides.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sun Jan 14, 2018 6:48 pm

UpperNwGuy wrote:
Sun Jan 14, 2018 6:26 pm
Sandtrap wrote:
Sun Jan 14, 2018 3:22 pm
Does it matter much if I have 50% Total Bond VBTLX Admiral and 50% VWIUX Int Term Tax Exempt Admiral
or 100% VWIUX tax exempt int term admiral?
This is my plan, but I'm in the break-even 25% (now 24%) tax bracket. It is my understanding that these two funds have no overlap whatsoever, so I like the diversification that the 50/50 split provides.
I though there was some overlap and some redundancy. Please explain.
thanks,
j :D

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by pezblanco » Sun Jan 14, 2018 7:00 pm

grabiner wrote:
Sun Jan 14, 2018 2:54 pm
My rule of thumb is that 25% is the break-even for taxable versus tax-exempt bonds; that is, bonds of comparable risk will have comparable returns at a 25% tax rate. At a 32% tax rate, you can get higher returns for the same level of risk, or lower risk for the same return, so you should use all munis if you hold bonds in your taxable account.

Vanguard Intermediate-Term Tax-Exempt tends to be the default recommendation of Bogleheads, because it is similar in risk to Total Bond Market and thus fills the same role in your portfolio.

Does Vanguard have a fund for your state? If so, you could consider putting half your bonds in that state's long-term fund, and half in Limited-Term Tax-Exempt, for an overall intermediate duration with better diversification than putting everything in your state, and more than half of your income exempt from state tax.
Sorry Grabiner to keep on asking you bond questions ... I never did really understand them.

Why is 25% the break-even point? Do we not look at SEC yields to determine this? Total Bond is 2.61% .. Tax-Exempt is 2.14% Wouldn't that make the break even point 2.61(1-x) = 2.14 or x = 18% right now?

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by grabiner » Sun Jan 14, 2018 7:15 pm

pezblanco wrote:
Sun Jan 14, 2018 7:00 pm
grabiner wrote:
Sun Jan 14, 2018 2:54 pm
My rule of thumb is that 25% is the break-even for taxable versus tax-exempt bonds; that is, bonds of comparable risk will have comparable returns at a 25% tax rate.
Sorry Grabiner to keep on asking you bond questions ... I never did really understand them.

Why is 25% the break-even point? Do we not look at SEC yields to determine this? Total Bond is 2.61% .. Tax-Exempt is 2.14% Wouldn't that make the break even point 2.61(1-x) = 2.14 or x = 18% right now?
25% is a rule of thumb. The only theoretical basis for the value is that it should be in the middle of the tax brackets. If the break-even for bonds of comparable risk were 40%, nobody would buy munis because tax rates aren't that high. If it were 15%, everyone would buy munis and nobody would buy corporate bonds in a taxable account.

The problem with looking at SEC yields is that they do not account for risk. In a 25% bracket, Total Bond Market would yield 1.96% after tax, and Intermediate-Term Tax-Exempt would yield 2.14% tax-free. That may still be break-even, because investors may believe that Intermediate-Term Tax-Exempt has slightly more risk.
Wiki David Grabiner

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by hudson » Sun Jan 14, 2018 7:26 pm

I think that it pays to do the math for your own situation. When comparing munis to something else, I would look at the SEC yield and the Distribution Yield for each fund. Then I would run the results for SEC and Distribution Yields for each through my tax software to see the result.

I like VWIUX; Baird's BMBIX has lower yield but is safer. Without looking I would say that VWIUX is rated AAA/AA/A; BMBIX is rated AAA/AA.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by UpperNwGuy » Sun Jan 14, 2018 7:36 pm

Sandtrap wrote:
Sun Jan 14, 2018 6:48 pm
I though there was some overlap and some redundancy. Please explain.
VBTLX is all Treasuries and corporates. VWIUX is all municipals. Hence, no overlap.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sun Jan 14, 2018 9:05 pm

UpperNwGuy wrote:
Sun Jan 14, 2018 7:36 pm
Sandtrap wrote:
Sun Jan 14, 2018 6:48 pm
I though there was some overlap and some redundancy. Please explain.
VBTLX is all Treasuries and corporates. VWIUX is all municipals. Hence, no overlap.
Right. :oops:
Brain fart.
thanks,
j :D

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by inbox788 » Sun Jan 14, 2018 9:13 pm

No tax advantaged space? Or maxed out?

https://www.bogleheads.org/wiki/Tax-eff ... _placement

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Sun Jan 14, 2018 10:24 pm

inbox788 wrote:
Sun Jan 14, 2018 9:13 pm
No tax advantaged space?
Or maxed out?
https://www.bogleheads.org/wiki/Tax-eff ... _placement
none
thanks,
j :D

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by kenoryan » Mon Jan 15, 2018 10:52 am

How low is the potential downside for vwiux? In % from current NAV

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by dbr » Mon Jan 15, 2018 10:57 am

kenoryan wrote:
Mon Jan 15, 2018 10:52 am
How low is the potential downside for vwiux? In % from current NAV
To know things like that you have to have an estimate of future interest rate moves. I don't have such a thing. Maybe someone else does.

Maybe a different question that puts a stake in the ground is how large a downturn in the value of your holding would be a problem for you and why?

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by hudson » Mon Jan 15, 2018 11:35 am

kenoryan wrote:
Mon Jan 15, 2018 10:52 am
How low is the potential downside for vwiux? In % from current NAV
Isn't there an argument that if you buy a quality intermediate bond fund like VWIUX or BMBIX and hold it for the long term, that you will be OK?
Higher interest rates will eventually make up any losses. There's also tax loss harvesting that can temper any losses.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by dbr » Mon Jan 15, 2018 11:49 am

hudson wrote:
Mon Jan 15, 2018 11:35 am
kenoryan wrote:
Mon Jan 15, 2018 10:52 am
How low is the potential downside for vwiux? In % from current NAV
Isn't there an argument that if you buy a quality intermediate bond fund like VWIUX or BMBIX and hold it for the long term, that you will be OK?
Higher interest rates will eventually make up any losses. There's also tax loss harvesting that can temper any losses.
It all depends on what one means by OK.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by inbox788 » Mon Jan 15, 2018 12:54 pm

kenoryan wrote:
Mon Jan 15, 2018 10:52 am
How low is the potential downside for vwiux? In % from current NAV
If the rule of thumb is correct, VWIUX with a duration of 5 years, and interest rate increase of 1-2% would put the downside at 5-10%. Your yield would go up by 1-2%, so you'd make it up in about 5 years, if all else stays the same (which it never does).

Drops in 2010 and 2012 were about 5% and end of 2016 was 4%. Going back to 2008 the drop was 6%. What would be the most appropriate rate change chart to compare?

http://www.macrotrends.net/2522/5-year- ... ield-chart
So how does this actually work? As a general rule, for every 1% increase or decrease in interest rates, a bond's price will change approximately 1% in the opposite direction for every year of duration.
https://www.blackrock.com/investing/res ... g-duration

BTW, I've been using intermediate tax exempt as part of my emergency fund, and I've been planning an extra 10-20% downside. Seems like 10% may be enough.

And as far as the original question, I'm in the 100% camp.

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by Sandtrap » Tue Jan 16, 2018 10:57 am

inbox788 wrote:
Mon Jan 15, 2018 12:54 pm
kenoryan wrote:
Mon Jan 15, 2018 10:52 am
How low is the potential downside for vwiux? In % from current NAV
If the rule of thumb is correct, VWIUX with a duration of 5 years, and interest rate increase of 1-2% would put the downside at 5-10%. Your yield would go up by 1-2%, so you'd make it up in about 5 years, if all else stays the same (which it never does).

Drops in 2010 and 2012 were about 5% and end of 2016 was 4%. Going back to 2008 the drop was 6%. What would be the most appropriate rate change chart to compare?

http://www.macrotrends.net/2522/5-year- ... ield-chart
So how does this actually work? As a general rule, for every 1% increase or decrease in interest rates, a bond's price will change approximately 1% in the opposite direction for every year of duration.
https://www.blackrock.com/investing/res ... g-duration

BTW, I've been using intermediate tax exempt as part of my emergency fund, and I've been planning an extra 10-20% downside. Seems like 10% may be enough.

And as far as the original question, I'm in the 100% camp.
Thanks for the help.
Please explain "downside"?
Why 100% and not a percentage mix with "Total Bond" in taxable?
mahalo,
j

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Re: Move to Tax-Exempt Bond in 32% Tax Bracket? What Proportion?

Post by inbox788 » Tue Jan 16, 2018 11:43 am

Sandtrap wrote:
Tue Jan 16, 2018 10:57 am
Please explain "downside"?
Why 100% and not a percentage mix with "Total Bond" in taxable?
Downside: Bonds are not risk free, but in recent downturns, the worst drops have been less than 10%. So if I needed say $10k in an emergency, FCID insured accounts would have the full amount, but bonds have a downside risk. If I added 10% extra, so $11k in a bond, and the timing is such that the bond fund is down 10% exactly when I need it, I still have access to $10k. A very unlikely black swan might even be worse, but I'm willing to take the risk.
grabiner wrote:
Sun Jan 14, 2018 7:15 pm
25% is a rule of thumb. The only theoretical basis for the value is that it should be in the middle of the tax brackets. If the break-even for bonds of comparable risk were 40%, nobody would buy munis because tax rates aren't that high. If it were 15%, everyone would buy munis and nobody would buy corporate bonds in a taxable account.

The problem with looking at SEC yields is that they do not account for risk. In a 25% bracket, Total Bond Market would yield 1.96% after tax, and Intermediate-Term Tax-Exempt would yield 2.14% tax-free. That may still be break-even, because investors may believe that Intermediate-Term Tax-Exempt has slightly more risk.
viewtopic.php?p=3723674#p3721051

100% Tax Exempt: Yield/greed! grabiner explained it well. If the 25% rule of thumb holds true, the after tax expected yield for those in the 25% tax bracket are similar between Muni vs Total Bond. Those in higher brackets will benefit from higher after tax yield in Munis. The after tax yield for Total Bond will be even lower than the 1.96%. Also, I don't mind the extra risk/reward from the Muni's, so another variable for higher yield. It's no free lunch, but again, I'm willing to assume the risk. I view it as a slight risk I can live with. Other may be more conservative.

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