Considering adding VWALX; pros-cons

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underwood
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Considering adding VWALX; pros-cons

Post by underwood » Tue Jun 19, 2018 9:48 pm

I currently hold a considerable amount of VWIUX (intermediate term muni). I have some cash to invest and considering adding VWALX (high yield muni).

I understand that VWALX has longer duration and greater credit risk and overtime has outperformed VWIUX.

Was hoping that others with more knowledge than I could speak to the pros and cons of this fund relative to VWIUX, especially in the current time of rising interest rates.

Much appreciated.

bloom2708
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Re: Considering adding VWALX; pros-cons

Post by bloom2708 » Wed Jun 20, 2018 8:15 am

Add 5% to the stock side/allocation of your portfolio if you want to reach for more return.

Stick with Int-Term Tax-Exempt in this rising interest rate environment.

High yield will lower the quality, extend the duration out or both. The bond side is for stability and some return.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

underwood
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Re: Considering adding VWALX; pros-cons

Post by underwood » Wed Jun 20, 2018 8:59 am

Add 5% to the stock side/allocation of your portfolio if you want to reach for more return.

Stick with Int-Term Tax-Exempt in this rising interest rate environment.
Thanks for the response. As I move into retirement I am looking to reduce my equity allocation currently at 65%; down to ~ 50-50 . The bond funds I am purchasing will be held for the long run (remainder of my life)

I get confused when thinking about bond fund performance from a buy and hold perspective. If I am going to hold these funds long term then how important is the variability of the NAV (as long as its holds over the long term) verses the income yield. The income yield is what will provide the cash flow for living expenses so isn't that what is most important in the long run?

I struggle to get my head around the issue of the volatility of bond fund NAV verses the fund income yield, and appreciate hearing from anyone that has suggestions on how to quantify the trade offs.

bloom2708
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Re: Considering adding VWALX; pros-cons

Post by bloom2708 » Wed Jun 20, 2018 9:17 am

I understand.

The high yield/junk bonds tend to act like stocks when stocks are dipping/dropping. That is not what you want from the bond side of your portfolio.

I am ok with back testing in certain scenarios. Look and see how VWALX did during the 2007 to 2009/10 market swoons.

The best scenario is to have Total US + Total International in taxable and put Total US Bond in your 401k/Rollover IRA. But, I also understand that in retirement you may not want taxable 100% stocks.

My parents use Vanguard Tax Managed Balanced fund in taxable. It is ~47/53 and does some of that mixing of bonds and duration to get a decent return.

Hopefully others will add their ideas.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

informal guide
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Re: Considering adding VWALX; pros-cons

Post by informal guide » Wed Jun 20, 2018 9:51 am

I understand and appreciate the view that higher yield bonds act more like equities. Yet my personal philosophy is to have 10-15% of my bond allocation in high yield bonds to improve the income generated for spending in retirement. Yes the price is more volatile than Treasuries, particularly in times of market stress (e.g., 2008-2009). But the income is more stable even if there are significant price declines over the short term.

I like the fact that Vanguard high yield bonds are higher quality than the competition's high yield bonds. In fact the peer group for the high yield tax exempt is the BloomBarc muni bond index, not a high yield muni index. Less than 8% is below BBB (investmeent grade). Similarly, the High yield Corporate (managed by Wellington Management) "seeks to purchase what the advisor considers higher-rated junk bonds."

If you are moving significant assets from stocks to bonds, you may wish to consider dollar cost averaging out of stocks into into bonds over 3-6 months.

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Re: Considering adding VWALX; pros-cons

Post by dbr » Wed Jun 20, 2018 10:15 am

underwood wrote:
Wed Jun 20, 2018 8:59 am
Add 5% to the stock side/allocation of your portfolio if you want to reach for more return.

Stick with Int-Term Tax-Exempt in this rising interest rate environment.
Thanks for the response. As I move into retirement I am looking to reduce my equity allocation currently at 65%; down to ~ 50-50 . The bond funds I am purchasing will be held for the long run (remainder of my life)

I get confused when thinking about bond fund performance from a buy and hold perspective. If I am going to hold these funds long term then how important is the variability of the NAV (as long as its holds over the long term) verses the income yield. The income yield is what will provide the cash flow for living expenses so isn't that what is most important in the long run?

I struggle to get my head around the issue of the volatility of bond fund NAV verses the fund income yield, and appreciate hearing from anyone that has suggestions on how to quantify the trade offs.
Sure the quantification is that the two numbers that define the performance of an investment are the return and the variability of the return over time. More specifically one usually looks at the annual return, which is the sum result of dividends paid and change in NAV relative to the share price. Both can be variable. The variability of return is typically measured as standard deviation of annual returns. For a cosmic overview of what can be expected from these numbers an estimate such as this one might be consulted: https://portfoliosolutions.com/latest-l ... n-forecast High yield munis are not there but one could compare high yield corporates at 6% return and 15% SD to one month T-bills at 2% yield and 2% SD. For perspective US stocks tend to run in the range 7% return and 20% SD. So there you have candy bars, ice cream, and carrots (see below). Note that even one month bills have a volatility of return because interest rates vary and you get a new interest rate every month.

The concern of interest is the volatility vs the return of the whole portfolio. Decreasing stock holding for a risker bond holding goes halfway to reducing portfolio risk and is therefore somewhat pointless. If you want a portfolio with more return, hold more in stocks and if you want a portfolio with less risk, hold less in stocks. The stock/bond ratio is not a primary objective. The effect of stock/bond ratio on portfolio risk and return for whatever investments you hold is the tool you use to achieve the primary objective of risk and return.

To use a metaphor (which I usually hate to do), cutting down on sugar in your diet by eliminating candy bars and replacing them with ice cream instead of an apple or even better a carrot is probably not the best health advice.

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BolderBoy
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Re: Considering adding VWALX; pros-cons

Post by BolderBoy » Wed Jun 20, 2018 12:07 pm

underwood wrote:
Tue Jun 19, 2018 9:48 pm
Was hoping that others with more knowledge than I could speak to the pros and cons of this fund relative to VWIUX, especially in the current time of rising interest rates.
The primary purpose of bonds in a portfolio is to mitigate risk. A common wisdom is to take your risks on the stock side of your portfolio where you can. So while the pro of the high-yield muni may be higher immediate income, you've outlined the cons already.

Just keep in mind that the high-yield muni is going to act stock-like and be prepared for possible disappointment if you want it to, "behave like a bond".
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

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MP123
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Re: Considering adding VWALX; pros-cons

Post by MP123 » Wed Jun 20, 2018 12:46 pm

bloom2708 wrote:
Wed Jun 20, 2018 9:17 am
I am ok with back testing in certain scenarios. Look and see how VWALX did during the 2007 to 2009/10 market swoons.
Total return for VWALX in 2008 was -10.39% vs VTI (total stock market) at -36.97%.

So certainly not as stable as a savings account but not really anywhere near as volatile as stocks during that period at least.

As High Yield muni funds go VWALX is pretty conservative, holding higher quality bonds. Last time I checked they weren't holding any Tobacco Settlement Bonds either which some other High Yield muni funds do.

High yield (both muni and corp) bonds don't get much support on this site but I think they're useful if you know what you're getting into.

bloom2708
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Re: Considering adding VWALX; pros-cons

Post by bloom2708 » Wed Jun 20, 2018 12:57 pm

MP123 wrote:
Wed Jun 20, 2018 12:46 pm
bloom2708 wrote:
Wed Jun 20, 2018 9:17 am
I am ok with back testing in certain scenarios. Look and see how VWALX did during the 2007 to 2009/10 market swoons.
Total return for VWALX in 2008 was -10.39% vs VTI (total stock market) at -36.97%.

So certainly not as stable as a savings account but not really anywhere near as volatile as stocks during that period at least.

As High Yield muni funds go VWALX is pretty conservative, holding higher quality bonds. Last time I checked they weren't holding any Tobacco Settlement Bonds either which some other High Yield muni funds do.

High yield (both muni and corp) bonds don't get much support on this site but I think they're useful if you know what you're getting into.
Right. The return on Total US Bond (VBTLX) in 2008 was +5.15%. 15.5% better than the high yield bond fund mentioned. -07% in 2008 for VWIUX (Int-Term Tax-Exempt). That could be significant if retired with a large portion in bond funds. Like most things. No consensus. Just different perspectives to look at and take into consideration.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

underwood
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Re: Considering adding VWALX; pros-cons

Post by underwood » Wed Jun 20, 2018 11:57 pm

The primary purpose of bonds in a portfolio is to mitigate risk. A common wisdom is to take your risks on the stock side of your portfolio where you can. So while the pro of the high-yield muni may be higher immediate income, you've outlined the cons already.

Just keep in mind that the high-yield muni is going to act stock-like and be prepared for possible disappointment if you want it to, "behave like a bond".
I appreciate the responses but remain confused.


Increased predictable income is the main motivation for turning to Bonds, not to reduce risk or to avoid the volatility of stocks. t I would prefer not to count on selling stocks to provide cash flow for expenses, especially during downturns. Yes I understand that the yield from bond funds will vary over time due to fluctuations in underlying interest rates, but I am willing to live with that (plus with interest rates still historically low it seems that yields are more likely to go up than down). But why should I care that if the NAV of the fund has gone down by 10% (20,30,..%) in any given year as long as the fund keeps providing the same income. The NAV loss is just on paper, and does not impact cashflow, right? Or am I not understanding that if the NAV goes down by 10% so will the income my bond fund pays out? ( the bond fund still holds the same bonds which still pay out the same coupons, regardless of NAV, doesn't it?)

radiowave
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Re: Considering adding VWALX; pros-cons

Post by radiowave » Thu Jun 21, 2018 7:37 am

The Vanguard muni funds spit out a lot of dividends which adds to your MAGI. That may or may not be a concern from a tax standpoint.
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dbr
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Re: Considering adding VWALX; pros-cons

Post by dbr » Thu Jun 21, 2018 8:17 am

underwood wrote:
Wed Jun 20, 2018 11:57 pm
The primary purpose of bonds in a portfolio is to mitigate risk. A common wisdom is to take your risks on the stock side of your portfolio where you can. So while the pro of the high-yield muni may be higher immediate income, you've outlined the cons already.

Just keep in mind that the high-yield muni is going to act stock-like and be prepared for possible disappointment if you want it to, "behave like a bond".
I appreciate the responses but remain confused.


Increased predictable income is the main motivation for turning to Bonds, not to reduce risk or to avoid the volatility of stocks. t I would prefer not to count on selling stocks to provide cash flow for expenses, especially during downturns. Yes I understand that the yield from bond funds will vary over time due to fluctuations in underlying interest rates, but I am willing to live with that (plus with interest rates still historically low it seems that yields are more likely to go up than down). But why should I care that if the NAV of the fund has gone down by 10% (20,30,..%) in any given year as long as the fund keeps providing the same income. The NAV loss is just on paper, and does not impact cashflow, right? Or am I not understanding that if the NAV goes down by 10% so will the income my bond fund pays out? ( the bond fund still holds the same bonds which still pay out the same coupons, regardless of NAV, doesn't it?)
The overall prospect for taking income from a portfolio of bonds before the portfolio is eventually exhausted and fails has been studied many times, starting with the Trinity Study back in 1992 or so. The result is that if one tries to take an inflation indexed 3% of initial portfolio value or less withdrawal from a portfolio then about any allocation of stocks and bonds will last 30 years or more before failing. To take as much as 4% one needs at least 30% or so in stocks or the rates of failure become quite large when supported only by bonds. It is possible to configure a ladder of 30 year TIPS for 30 years of income and deliberately exhaust the portfolio at exactly 30 years. At 0% real interest rates such a portfolio allows a 3.33% withdrawal rate. At 1% real interest rate that grows to 3.88%. An inflation indexed lifetime annuity can probably be held by a retiree at about 4% payout for life, and withdrawal at a safe rate from a portfolio of stocks and bonds probably allows about 4% inflation indexed for 30 years with almost all outcomes being better than that.

Your scheme does not allow for inflation of income needed to support future expenses and probably spends less than you could spend. By identifying income with interest paid you can also spend more than can be sustained.

underwood
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Re: Considering adding VWALX; pros-cons

Post by underwood » Thu Jun 21, 2018 7:11 pm

The overall prospect for taking income from a portfolio of bonds before the portfolio is eventually exhausted and fails has been studied many times, starting with the Trinity Study back in 1992 or so. The result is that if one tries to take an inflation indexed 3% of initial portfolio value or less withdrawal from a portfolio then about any allocation of stocks and bonds will last 30 years or more before failing. To take as much as 4% one needs at least 30% or so in stocks or the rates of failure become quite large when supported only by bonds. It is possible to configure a ladder of 30 year TIPS for 30 years of income and deliberately exhaust the portfolio at exactly 30 years. At 0% real interest rates such a portfolio allows a 3.33% withdrawal rate. At 1% real interest rate that grows to 3.88%. An inflation indexed lifetime annuity can probably be held by a retiree at about 4% payout for life, and withdrawal at a safe rate from a portfolio of stocks and bonds probably allows about 4% inflation indexed for 30 years with almost all outcomes being better than that.
Thanks... but getting lost. As mentioned I currently have 65% in equities and looking to bring that down to 50-50 equities and bonds. I am trying to understand pros and cons of putting some of my bond allocation in VWALX to boost income yield. I understand that this may make the NAV of my bond holdings more volatile, but I don't understand why I should care about the NAV of the bond funds if I intend to hold indefinitely.

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goingup
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Re: Considering adding VWALX; pros-cons

Post by goingup » Thu Jun 21, 2018 7:45 pm

underwood-
Not an expert on this, but these are longer term and lower credit quality bonds. Hence Vanguard's risk rating of a 3 rather than the 2 for Intermediate Term Tax Exempt. If you want to juice monthly returns it's perfectly reasonable to add a slice, recognizing that the NAV will fluctuate more than shorter term better quality bond funds. Personally, I wouldn't want these to represent more than 15-20% of my bond holdings. It's the same ole risk-reward story and you're going into it with eyes wide-open. :beer

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Re: Considering adding VWALX; pros-cons

Post by grabiner » Sat Jun 23, 2018 3:11 pm

underwood wrote:
Wed Jun 20, 2018 8:59 am
Add 5% to the stock side/allocation of your portfolio if you want to reach for more return.

Stick with Int-Term Tax-Exempt in this rising interest rate environment.
Thanks for the response. As I move into retirement I am looking to reduce my equity allocation currently at 65%; down to ~ 50-50 . The bond funds I am purchasing will be held for the long run (remainder of my life)

I get confused when thinking about bond fund performance from a buy and hold perspective. If I am going to hold these funds long term then how important is the variability of the NAV (as long as its holds over the long term) verses the income yield. The income yield is what will provide the cash flow for living expenses so isn't that what is most important in the long run?
Only if the bonds don't default. Lower-quality bonds may default, or may be sold by the fund for a capital loss once the default risk has increased. This is the problem with spending income from such funds; your principal will decline, and the ability of that principal to generate income will also decline.

That said, Vanguard High-Yield Tax-Exempt isn't really a junk fund. It is a bit riskier than Vanguard's regular muni funds, but it holds mostly A and BBB-rated bonds, with only 7% junk-rated (BB or lower) and 9% unrated. For comparison, Intermediate-Term Tax-Exempt holds 8% BBB, 1% BB or lower, and 1% unrated.

From a risk standpoint, it's probably best to consider Intermediate-Term Tax-Exempt as similar to a broad-market bond fund such as Total Bond Market Index, and High-Yield Tax-Exempt as similar to an all-corporate fund such as Intermediate-Term Corporate Bond Index. (Bond traders believe this as well; both pairs listed here have about the same yield on Admiral shares in a 22% tax bracket.)
Wiki David Grabiner

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