For munis: state specific or non-state specific funds best?

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sitout
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For munis: state specific or non-state specific funds best?

Post by sitout » Mon Feb 19, 2018 8:27 am

I see many recommendations here for Vanguard’s intermediate term muni fund VWITX for muni investments. For muni purchases by residents of relatively high state-tax jurisdictions, is it generally always better to invest in a state-specific fund (e.g., Vanguard’s Mass. tax-exempt VMATX or N.J. tax-exempt VNJTX)?

Or do certain benefits such as diversity of assets warrant investing in the non-state specific VWITX even if sizable state taxes must be endured?

Thanks for any comments.

MikeG62
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Re: For munis: state specific or non-state specific funds best?

Post by MikeG62 » Mon Feb 19, 2018 9:19 am

When I began building my muni bond portfolio and during most of my working career, I purchased only muni bonds issued in my home state (NJ). I was a high wage earner and I wanted the state tax benefit (i.e., wanted to avoid paying state income tax on the interest income). In the last several years of my working career, I began purchasing only out-of-state muni bonds to diversify my holdings.

My muni bond position is now about 65% in state and 35% out of state. As I continue to add to my muni bond position (still putting excess cash to work from the last few years of working) I purchase only out of state muni bonds. Ideally I’d like to be at the point where I hold no more than 50% of my muni’s issued in a single state. Over time, I plan to continue to shift more and more toward out of state bonds (as my existing muni’s get called or mature, I will replace them with bonds issued outside from home state).

While it’s still not as tax efficient, to me the benefits of diversification coupled with the ability to pick from a much larger pool of bonds more than outweighs the higher state income tax cost.

FWIW, I do not own any muni bond funds. All my muni’s are held in individual bonds purchased in the secondary market, one at a time (I own many dozens of individual bonds). This is not to say that investing in muni’s in a bond fund is a bad idea. It’s just the way I choose to do it.

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MP123
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Re: For munis: state specific or non-state specific funds best?

Post by MP123 » Mon Feb 19, 2018 1:49 pm

To really answer the question you'd need to know your Federal and State tax rates and the yields on the state specific and nationwide muni funds. The yield on an equivalent risk non-muni fund too would be good for comparison. This will give you a mathematical answer.

But the part that's hard to quantify and calculate is the benefits of diversification and the risk of a single state fund.

I live in a state without income tax so the choice is easy for me - nationwide funds. I would think that in some states a state specific fund might be a bit riskier (IL for example, meaning no offense to anyone).

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triceratop
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Re: For munis: state specific or non-state specific funds best?

Post by triceratop » Mon Feb 19, 2018 2:01 pm

A common recommendation by forum member grabiner is to split the difference, and in a smart way if you're targeting Intermediate-term duration. Since the benefit is more for higher yielding funds, you can construct an intermediate-term bond portfolio with Long-term state-specific and limited-term national muni funds. This has the benefit that while your funds are more diversified at an asset-level view, you receive much of your income entirely tax-free.
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Re: For munis: state specific or non-state specific funds best?

Post by sport » Mon Feb 19, 2018 2:15 pm

triceratop wrote:
Mon Feb 19, 2018 2:01 pm
A common recommendation by forum member grabiner is to split the difference, and in a smart way if you're targeting Intermediate-term duration. Since the benefit is more for higher yielding funds, you can construct an intermediate-term bond portfolio with Long-term state-specific and limited-term national muni funds. This has the benefit that while your funds are more diversified at an asset-level view, you receive much of your income entirely tax-free.
I have been following this recommendation and I am happy with it. I use the Vanguard Ohio Long Term TE fund and the Vanguard Limited Term TE fund in a 50/50 split.

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Re: For munis: state specific or non-state specific funds best?

Post by mega317 » Mon Feb 19, 2018 2:36 pm

I have only statespecificc munis -- in taxable. More than half of my bonds are in total bond in tax deferred accounts.

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Clever_Username
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Re: For munis: state specific or non-state specific funds best?

Post by Clever_Username » Mon Feb 19, 2018 7:46 pm

I'm in California intermediate-term at the moment. However, as the actual dollar amount increases, I might follow this advice:
triceratop wrote:
Mon Feb 19, 2018 2:01 pm
A common recommendation by forum member grabiner is to split the difference, and in a smart way if you're targeting Intermediate-term duration. Since the benefit is more for higher yielding funds, you can construct an intermediate-term bond portfolio with Long-term state-specific and limited-term national muni funds. This has the benefit that while your funds are more diversified at an asset-level view, you receive much of your income entirely tax-free.
Right now, though, my bonds outside of Series I and total bond in retirement accounts is CA Intermed Term and is in the low five figures, not qualifying even for Admiral yet. I will have to figure out when to make the switch at some point.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

jrbdmb
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Re: For munis: state specific or non-state specific funds best?

Post by jrbdmb » Tue Feb 20, 2018 11:46 am

It also depends on the credit rating of your state. I live in New Jersey, which has slid from a AA rating in 2010 to a A- rating in 2017. I am willing to pay extra state income tax to avoid the potential financial abyss NJ appears to be headed towards.

Likewise, I would never consider an Illinois (BBB- rating) muni fund.

S&P credit ratings from: https://ballotpedia.org/State_credit_ratings

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Clever_Username
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Re: For munis: state specific or non-state specific funds best?

Post by Clever_Username » Tue Feb 20, 2018 3:20 pm

jrbdmb wrote:
Tue Feb 20, 2018 11:46 am
It also depends on the credit rating of your state. I live in New Jersey, which has slid from a AA rating in 2010 to a A- rating in 2017. I am willing to pay extra state income tax to avoid the potential financial abyss NJ appears to be headed towards.

Likewise, I would never consider an Illinois (BBB- rating) muni fund.

S&P credit ratings from: https://ballotpedia.org/State_credit_ratings
Huh, good point ... what does AA- mean (California)?
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

Captain kangaroo
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Re: For munis: state specific or non-state specific funds best?

Post by Captain kangaroo » Wed Feb 21, 2018 12:09 pm

I am thinking about going 50/50.

50% Fidelity Tax-Free Bond Fund VTABX
50% T. Rowe Price Maryland Tax Free Fund MDXBX ER .45%

Maryland has had 20 years of being rated AAA and MD. and VTABX just for a little more diversification.

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Re: For munis: state specific or non-state specific funds best?

Post by scrabbler1 » Wed Feb 21, 2018 12:44 pm

I have been in the 50/50 neighborhood since the late 1990s. Some years, I had a little more in the instate bond fund, some years I had more in the national ones. Now it is very close to 50/50. The instate fund is long-term, the national fund is intermediate-term and acts as my second-tier EF because it still has checkwriting privileges, a nice plus. (The instate fund used to have checkwriting, too, but they took it away for an unusual reason a few years ago.)

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grabiner
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Re: For munis: state specific or non-state specific funds best?

Post by grabiner » Wed Feb 21, 2018 9:45 pm

jrbdmb wrote:
Tue Feb 20, 2018 11:46 am
It also depends on the credit rating of your state. I live in New Jersey, which has slid from a AA rating in 2010 to a A- rating in 2017. I am willing to pay extra state income tax to avoid the potential financial abyss NJ appears to be headed towards.
Look at the rating of the bonds held by the fund, not just the state. High-rated states can have bonds issued by low-rated cities and revenue authorities, and vice versa. Vanguard's NJ fund is recognized as risky (with a 3.04% yield on Admiral shares to reflect that risk), as it holds only 27% of bonds rated AA or better, 34% A, 37% BBB, and 2% junk or unrated. That is rather risky for a core bond fund, so I would recommend putting only half your bonds there, and the other half in a high-quality and well-diversified national fund.
Wiki David Grabiner

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Re: For munis: state specific or non-state specific funds best?

Post by Noobvestor » Wed Feb 21, 2018 10:51 pm

Whenever I've run the numbers on state-specific versus federal muni funds (adjusting for taxes), they have come out around even (and that's being in CA, a high-state-tax state). I would recommend doing the math on your tax bracket with actual fund yields. When the results are close to the same, I have to ask myself: do I want to take on concentration/regional risk for a tiny bit more yield? Personal answer has always been 'no'.

And now that muni yields are down and Treasury yields are up, I can't justify munis anymore, even in taxable accounts. Why take the risk for a few tenths of a percent? I just recently sold out of Vanguard Intermediate-Term Tax Exempt for Vanguard Intermediate-Term Treasury Index.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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grabiner
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Re: For munis: state specific or non-state specific funds best?

Post by grabiner » Wed Feb 21, 2018 11:42 pm

Noobvestor wrote:
Wed Feb 21, 2018 10:51 pm
Whenever I've run the numbers on state-specific versus federal muni funds (adjusting for taxes), they have come out around even (and that's being in CA, a high-state-tax state).

When comparing muni funds, it's better to compare the taxes assuming the same yield; any yield difference is compensation for risk, not a free lunch. If a CA fund has a lower yield than a national fund, this means that investors consider its bonds less risky. (And this is currently the case for Vanguard's CA and national long-term funds; the CA fund has fewer bonds rated A or lower, although it also has more AA and less AAA.) Conversely, the NJ fund has a higher yield than the national fund, because it has many more bonds rated A and BBB, and thus the higher pre-tax yield is a risk premium.
Wiki David Grabiner

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Re: For munis: state specific or non-state specific funds best?

Post by Noobvestor » Thu Feb 22, 2018 12:10 am

grabiner wrote:
Wed Feb 21, 2018 11:42 pm
Noobvestor wrote:
Wed Feb 21, 2018 10:51 pm
Whenever I've run the numbers on state-specific versus federal muni funds (adjusting for taxes), they have come out around even (and that's being in CA, a high-state-tax state).

When comparing muni funds, it's better to compare the taxes assuming the same yield; any yield difference is compensation for risk, not a free lunch. If a CA fund has a lower yield than a national fund, this means that investors consider its bonds less risky. (And this is currently the case for Vanguard's CA and national long-term funds; the CA fund has fewer bonds rated A or lower, although it also has more AA and less AAA.) Conversely, the NJ fund has a higher yield than the national fund, because it has many more bonds rated A and BBB, and thus the higher pre-tax yield is a risk premium.
This could be irrational and I'm open for being shown otherwise, but it seems like an investor should get a lot more return for taking state risk, beyond just credit quality parity. First, there' geographical risk - what if something happens at a state level, like a finance law or tax rate change? Or what if a state's funding situation changes, and call risk comes into play in a location-specific way? Then there's concentration risk - I assume (but again, haven't verified) that there are more bonds in play and thus less concentration risk in a national muni fund than any given state fund.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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