Municipal Bond Fund NAV and interest rates

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Eli79
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Municipal Bond Fund NAV and interest rates

Post by Eli79 » Sat Mar 10, 2018 3:53 pm

I own VWITX (Vanguard Intermediate-Term Tax-Exempt Fund) in my taxable. Plan to hold for at least 7 years.

Average duration profile is 5-6 years.
I understand that NAV will fluctuate.
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year. Yields will go up by a similar amount which leads to essentially to a wash and no net growth for the next few years.

2 questions:
1) Please explain what happens if I hold this fund long term. Does the principal loss get wiped out or reset? I am failing to grasp this concept.

2) is it just better to TLH and reinvest after a wash period at lower NAV?

visualguy
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Re: Municipal Bond Fund NAV and interest rates

Post by visualguy » Sat Mar 10, 2018 4:08 pm

My understanding is that you may need to hold it for close to twice the duration to get your principal plus interest based on the original yield. This is what could happen if interest rates keep going up.

Bond funds aren't a good place to be in a rising interest environment from my perspective, and it looks like that's finally where we are (although, who knows for sure about the future).

Personally, I don't like volatility and uncertainty on the fixed income part of my portfolio, so I stay away from bond funds, and invest in other types of fixed income which are easier to predict and understand.

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welderwannabe
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Re: Municipal Bond Fund NAV and interest rates

Post by welderwannabe » Sat Mar 10, 2018 4:15 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
I own VWITX (Vanguard Intermediate-Term Tax-Exempt Fund) in my taxable. Plan to hold for at least 7 years.

Average duration profile is 5-6 years.
I understand that NAV will fluctuate.
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year. Yields will go up by a similar amount which leads to essentially to a wash and no net growth for the next few years.
At this point 3 rate increases in 2018 are generally expected and therefore already baked into the cake. There shouldn't be much more NAV drop related to the 2018 rate increases, unless it starts to look more likely than not for a 4th increase this year. 2019 rate increases are a different story...the more 'in the future' things are the less they impact the bond prices because the less perceived certainty there is to the bond market.

I am largely holding strong in my intermediate term holdings and actually continue to add to them. My main changes were on the short end where I have substituted some cash for what used to be my short term bond holdings, but that was more of a change in AA strategy then anything else I suppose...or at least that is what I am telling myself so I dont feel like a market timer.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

Eli79
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Re: Municipal Bond Fund NAV and interest rates

Post by Eli79 » Sat Mar 10, 2018 4:17 pm

I hear you. That is my underlying concern.
While this not an emergency fund, you never know what life will throw at you. It would be nice to know that I could pull out this cash in 7 years or so without suffering a significant hit in my principal.

Tempted to move to Vanguard Municipal Money Market Fund (VMSXX) for a few years. ~1% (~1.5% tax equivalent yield)

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dm200
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Re: Municipal Bond Fund NAV and interest rates

Post by dm200 » Sat Mar 10, 2018 4:22 pm

The time (with 20/20 hindsight) to have moved from bond funds was a few months ago :)

The NAV will continue to change (both up and down), BUT there is no guarantee it will ever reach any previous high - although it might.

lack_ey
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Re: Municipal Bond Fund NAV and interest rates

Post by lack_ey » Sat Mar 10, 2018 4:24 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year. Yields will go up by a similar amount which leads to essentially to a wash and no net growth for the next few years.
No. Feds increasing the Federal funds rate (target) doesn't mean that these intermediate-term municipal bond yields will go up by the same amount (or at all), so the effect is unknown. Just look back to last year. The fund (VWITX) return was 4.54% in 2017 when the Fed funds rate was increased three times for 0.75% total. The effect on yields has to do with changing expectations and risk pricing, among other things.

If you mean 0.75% in 2018 and 2019 combined, this is probably less than the market expects now, so that might well in of itself not cause intermediate-term yields to be pushed up. If so, that would nevertheless be a significant yield curve flattening.

If you mean 0.75% in each of 2018 and 2019, then sure, that kind of implies that today's intermediate-term yields are a bit low (unless everybody thinks that's the end of the tightening and short rates are perhaps expected to drop later), so they would probably be pressed upwards, just quite possibly less than by 1.5%. Or it could be even more.
Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
1) Please explain what happens if I hold this fund long term. Does the principal loss get wiped out or reset? I am failing to grasp this concept.
I'm not sure how to interpret "wiped out" and "reset" in this context. If the principal value has declined from the bond yields increasing, the forward return from that point (in the absence of further movements) will be higher, taking the form of potentially the principal value increasing as well as interest payments increasing. Bond interest is passed along to the investor in the form of fund dividends. Because a fund cycles through bonds and has many investors potentially putting more money into the fund or taking it out, an exact breakdown is impossible.

For an individual bond, the interest relative to par value would be unchanged (though interest relative to current price would be slightly higher); the additional return that balances out the loss that was just experienced comes from the increase in price towards par. Thus the bond's yield-to-maturity or yield-to-call is higher.

In general there's nothing preventing yields from continuing to change.
Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
2) is it just better to TLH and reinvest after a wash period at lower NAV?
Whenever you have a loss and would like to realize capital losses, you could tax-loss harvest. You don't have to wait to reinvest; keep your risk exposures reasonably in line by investing in the interim in a similar (but not "substantially identical') fund or two. Then you can switch back to your preferred fund if you like.

visualguy
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Re: Municipal Bond Fund NAV and interest rates

Post by visualguy » Sat Mar 10, 2018 4:34 pm

Eli79 wrote:
Sat Mar 10, 2018 4:17 pm
I hear you. That is my underlying concern.
While this not an emergency fund, you never know what life will throw at you. It would be nice to know that I could pull out this cash in 7 years or so without suffering a significant hit in my principal.

Tempted to move to Vanguard Municipal Money Market Fund (VMSXX) for a few years. ~1% (~1.5% tax equivalent yield)
Also, a changing tax situation (such as upon retirement or loss of job) may make holding muni funds for the period of duration or twice duration not so attractive.

You can also look at CDs, individual bonds, etc.

rkhusky
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Re: Municipal Bond Fund NAV and interest rates

Post by rkhusky » Sat Mar 10, 2018 5:39 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
is it just better to TLH and reinvest after a wash period at lower NAV?
There is no guarantee that you will see a lower NAV if you wait.

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dm200
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Re: Municipal Bond Fund NAV and interest rates

Post by dm200 » Sun Mar 11, 2018 9:08 am

rkhusky wrote:
Sat Mar 10, 2018 5:39 pm
Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
is it just better to TLH and reinvest after a wash period at lower NAV?
There is no guarantee that you will see a lower NAV if you wait.
Absolutely correct..

Iliketoridemybike
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Re: Municipal Bond Fund NAV and interest rates

Post by Iliketoridemybike » Sun Mar 11, 2018 9:50 am

Buy the bonds, ladder them and keep until maturity. Bond funds right now are a bottomless pit.
Fidelity has a great ladder builder on their site or call customer service and they will build one for you based on your desired duration and quality level. I suggest high quality, 2 years or less.

mega317
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Re: Municipal Bond Fund NAV and interest rates

Post by mega317 » Sun Mar 11, 2018 11:26 am

Iliketoridemybike wrote:
Sun Mar 11, 2018 9:50 am
Buy the bonds, ladder them and keep until maturity. Bond funds right now are a bottomless pit.
Bottomless pit? How much have you lost?

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dm200
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Re: Municipal Bond Fund NAV and interest rates

Post by dm200 » Sun Mar 11, 2018 12:40 pm

mega317 wrote:
Sun Mar 11, 2018 11:26 am
Iliketoridemybike wrote:
Sun Mar 11, 2018 9:50 am
Buy the bonds, ladder them and keep until maturity. Bond funds right now are a bottomless pit.
Bottomless pit? How much have you lost?
Of course not -

make decisions you are cofortable with -- but not "bottomless pit"

The time to be concerned about bond fund losses is when you can do something about it -- BEFORE the NAV drops.

My #1 question to folks who worry after the NAV drops is why you are surprised. That is the way bond funds work.

hudson
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Re: Municipal Bond Fund NAV and interest rates

Post by hudson » Sun Mar 11, 2018 7:46 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
I own VWITX (Vanguard Intermediate-Term Tax-Exempt Fund) in my taxable. Plan to hold for at least 7 years.

Average duration profile is 5-6 years.
I understand that NAV will fluctuate.
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year. Yields will go up by a similar amount which leads to essentially to a wash and no net growth for the next few years.

2 questions:
1) Please explain what happens if I hold this fund long term. Does the principal loss get wiped out or reset? I am failing to grasp this concept.

2) is it just better to TLH and reinvest after a wash period at lower NAV?
VWITX is a great fund. I would just buy it and hold it. Tax loss harvest as needed.
No one knows what interest rates are going to do; rates are always going up and down. I believe VWITX will be fine for the long haul.
If you get overly worried about fluctuations, consider CDs....or split the difference.
Consider reading Larry Swedroe's bond book.

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grabiner
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Re: Municipal Bond Fund NAV and interest rates

Post by grabiner » Sun Mar 11, 2018 8:23 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
I own VWITX (Vanguard Intermediate-Term Tax-Exempt Fund) in my taxable. Plan to hold for at least 7 years.

Average duration profile is 5-6 years.
I understand that NAV will fluctuate.
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year.
There is more than one interest rate. If the Fed increases short-term rates, it does not follow that the rate on intermediate-term bonds will rise. Intermediate-term rates are set by bond traders, based on their expectation of future rates. In particular, bond traders already know that the federal funds rate is likely to increase in the next year, and their prices (and yields) for longer-term bonds already include that.

Therefore, while it is true that the NAV of the fund will drop by 4.5% if the yields on its bonds rise by 0.75%, there is no reason to expect that to happen next year.
Wiki David Grabiner

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ogd
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Re: Municipal Bond Fund NAV and interest rates

Post by ogd » Sun Mar 11, 2018 8:39 pm

Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
1) Please explain what happens if I hold this fund long term. Does the principal loss get wiped out or reset? I am failing to grasp this concept.
Since it's very unlikely that any of the bonds have actually defaulted (have not checked, but you'd hear about such things), the principal loss should be entirely recouped through higher yields over time. Indeed, you can think of it as the cost of adjusting to higher yields, with a formula that goes a bit like: $X at 1.61% yield for duration = $(X - L) at 2.25% yield for duration, if we compare with the yield lows of 1.6% of last year for example That's where the loss $L comes from. It's a bit more complicated in reality, with pricing applied to each individual bond in the fund, but that's the executive summary of it.

The additional gain might come as NAV increase, or it might come purely as yield; there are complex tax laws that tell the fund managers what they can't and can't do. In this case, you probably prefer extra yield because it's free of taxes unlike capital gains, but the fund isn't allowed to make the yield arbitrarily high. For taxable bonds, the opposite is true.

In any event, what's certainly true is that if you liked these bonds enough to hold them at 1.61% (the NAV having increased quite a bit at that point), there's little reason not to like them more at 2.25%. You paid the cost to adjust already, time to get the rewards.
Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
2) is it just better to TLH and reinvest after a wash period at lower NAV?
Tax loss harvesting sounds fine, but don't try to time the market. I typically harvest by moving into another muni fund for the wash period, rather than being out altogether -- I might miss a significant price / yield move in the opposite direction. Beware that for munis held less than 6 months there is a rule about the tax free dividends received in the interim -- when selling at a loss, the dividends have to be discounted from the loss to prevent gaming the dividend payment dates.
Eli79 wrote:
Sat Mar 10, 2018 3:53 pm
Assuming the feds increase interest rates by 0.75% in 2018 and 2019 this will equate to roughly drop in NAV by 4.5% per year. Yields will go up by a similar amount which leads to essentially to a wash and no net growth for the next few years.
As others have pointed out, these yields are set by the market not the Fed. If the market (consisting of highly experienced professionals) thought the yield will be 1.5% higher shortly, it would be that now. The advice to not time the market goes doubly so for bonds, where all the variables are visible to people who know the math, have degrees in it and use it to set the prices. Your best guess for return going forward is the SEC yield of the fund (2.25%) and not "a wash" due to things everyone knows.

One thing to remember is that a few years from now, the fund will still have a duration of 5 years, so if your timeline draws closer (if it even is a definite thing), you'd do well to shorter duration accordingly, using a shorter fund or a funds/cash mix. Other than that, everything from pricing to yield changes applies to a bond ladder just as well as funds -- the only difference is the ladder, if you do nothing, will get shorter and shorter by itself. The fund is, of course, far more diversified and liquid than one can hope to achieve in individual munis by themselves.

Hope this helps!

Iliketoridemybike
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Re: Municipal Bond Fund NAV and interest rates

Post by Iliketoridemybike » Mon Mar 12, 2018 7:16 am

mega317 wrote:
Sun Mar 11, 2018 11:26 am
Iliketoridemybike wrote:
Sun Mar 11, 2018 9:50 am
Buy the bonds, ladder them and keep until maturity. Bond funds right now are a bottomless pit.
Bottomless pit? How much have you lost?
As rates go up, the NAV will continue to drop. Now is not the time to be in a bond fund.

Eli79
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Re: Municipal Bond Fund NAV and interest rates

Post by Eli79 » Mon Mar 12, 2018 9:35 am

Thank you for your replies. Based on the variability of responses I realize that I am not the only one who really struggles with understanding muni bond funds. OGD etal seems to have a better grasp of things and I will take your recommendations to heart.

hudson
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Re: Municipal Bond Fund NAV and interest rates

Post by hudson » Mon Mar 12, 2018 10:09 am

ogd wrote:
Sun Mar 11, 2018 8:39 pm
Beware that for munis held less than 6 months there is a rule about the tax free dividends received in the interim -- when selling at a loss, the dividends have to be discounted from the loss to prevent gaming the dividend payment dates.
Let's say that one owned the OP's VWITX (Vanguard Intermediate-Term Tax-Exempt Fund). Some of the Spec-IDs were more than 6 months, some were less. The owner sold them to TLH, exchanging for say Vanguard Short-Term Tax-Exempt Fund Investor Shares (VWSTX)...for 31 days...then exchanged back to VWITX. Would that cause problems with the dividends?

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ogd
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Re: Municipal Bond Fund NAV and interest rates

Post by ogd » Mon Mar 12, 2018 1:47 pm

hudson wrote:
Mon Mar 12, 2018 10:09 am
ogd wrote:
Sun Mar 11, 2018 8:39 pm
Beware that for munis held less than 6 months there is a rule about the tax free dividends received in the interim -- when selling at a loss, the dividends have to be discounted from the loss to prevent gaming the dividend payment dates.
Let's say that one owned the OP's VWITX (Vanguard Intermediate-Term Tax-Exempt Fund). Some of the Spec-IDs were more than 6 months, some were less. The owner sold them to TLH, exchanging for say Vanguard Short-Term Tax-Exempt Fund Investor Shares (VWSTX)...for 31 days...then exchanged back to VWITX. Would that cause problems with the dividends?
The part of the sale that was shorter than 6 months would trigger the rule about disqualified loss. The exchanging back is not an issue, it's all about the sale.

However, I just looked this up in the Bogleheads wiki to post a reference (here it is: Fine points about tax loss harvesting), and noticed that the wiki says the rule doesn't apply to Vanguard muni funds because of some fine print to the fine print. I didn't know about any such exception -- having only ran into the issue long ago with an ETF -- and I trust the wiki more than myself. I would still triple verify and try to avoid the situation, but it might be okay nonetheless.

hudson
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6 month rule for tax exempt interest

Post by hudson » Mon Mar 12, 2018 7:37 pm

ogd wrote:
Mon Mar 12, 2018 1:47 pm
However, I just looked this up in the Bogleheads wiki to post a reference (here it is: Fine points about tax loss harvesting), and noticed that the wiki says the rule doesn't apply to Vanguard muni funds because of some fine print to the fine print. I didn't know about any such exception -- having only ran into the issue long ago with an ETF -- and I trust the wiki more than myself. I would still triple verify and try to avoid the situation, but it might be okay nonetheless.
Thanks ogd!
I followed your link to the WIKI and read the following:
Note that most Vanguard Tax Exempt funds (and others like them) are not subject to the preceding 6 month rule because of the way they accrue and pay out interest (dividends). The 6 month rule for tax exempt interest comes from 26 U.S. Code § 852(b)(4)(B), but there is an exception in 852(b)(4)(E) for funds that declare dividends daily and pay them monthly or more frequently.[3] [4]
However, ETFs and the Tax-Exempt Bond Index Fund (which is the mutual fund class of an ETF) are subject to the six-month rule, because they declare dividends monthly, not daily. To see whether a fund is exempt from the six-month rule, check its prospectus for the statement, "dividends are declared daily and paid monthly"; if it says "dividends are declared monthly" (or quarterly), the six-month rule applies.
I decided to find "dividends are declared daily and paid monthly" in the prospectus for VWIUX...Vang Intermediate Muni...Adm. I finally found it on page 46 of the "Statutory Prospectus."

Therefore VWITX and the Admiral version VWIUX don't have interest penalty problems during tax loss harvests.

How many people know about this? ...very technical...but very useful information!

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