Muni guidance for $15m portfolio

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crossroads
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Muni guidance for $15m portfolio

Post by crossroads » Sat Nov 09, 2019 7:41 pm

Hey, I've been lurking for the last few years but would love to get some personalized guidance on AA for on self managed portfolio.

Wife and I are both 35. Two young kids. We live in California, and plan to stay here.

Net worth is a little over $15m.
Annual earnings are in the $3m range, or $1.5m after tax. I may trade in my high stress/high pay job for something more family friendly in the next few years, so no guarantee that income stream continues.
$2m owed (just refinanced to < 2.5% on a 10/1 interest only, opting to earn more in market vs paying down the principal) on $4m house
Our expenses are on the high side, around 350k year (big items are mortgage, property tax, childcare, schools & travel, all in a very high cost of living area). Don't see it increasing much, though.
$1m space in tax advantaged, $5m space in taxable, $9m in a single publicly traded security (employer equity) that I'm diversifying over the next 12 months. That $9m will turn into $6.5 post tax after selling.

I realize the single stock risk is my biggest risk, but I'm selling on a schedule according to a 10b5-1 plan. Not a ton I can do (short of quitting my job) to burn this down faster. Given that, I'm leaning towards treating the other $6m of my portfolio conservatively to protect against macro/downturn risk, and putting the next 12 months of sale proceeds into VTSAX/VTIAX as they turn over.

From a risk perspective, I'm okay with 60/40 stocks/bonds. Going to treat my employer equity as 100% of the "60" for the next 12 months. But for bonds:

I hold 80% BND and 20% BNDX in my $1m of tax advantaged space, but am struggling with what to put in the other taxable $3-5m of bonds. Seems the advice on here is some combination of National and California Tax Exempt Munis (VCLAX & VMLUX), but the recommendations around short/intermediate/long term seem to pivot on predictions around what interest rates will do, which feels wrong, mostly because I have no idea what interest rates will look like over the next few years. Any advice on this?

And the reason I said $3-5m, is I have around $2m of appreciated equities holdings (some index funds, some lucky picks from a past life) that I'm struggling on whether to let "ride out" and be part of my 60% next year, or rip the bandaid off and sell (paying LTCG, likely 37% for me, in CA) to put in munis. Thoughts either way?

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Kevin M
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Re: Muni guidance for $15m portfolio

Post by Kevin M » Sat Nov 09, 2019 8:30 pm

I'd say the most common recommendation would be to pick one of the intermediate-term or long-term muni funds and just stick with it. Others are more worried about taking extra term risk with the yield curves relatively flat, so not much yield premium for taking the extra risk. There is something to be said for point of each view, so you have to make up your own mind.

I'll assume that your fed marginal tax rate is 37% and that you pay NIIT of 3.8%, for a total fed marginal tax rate of 40.7%, and I'll assume your state marginal tax rate is 13.3%. At these marginal tax rates, you have the following taxable-equivalent yields (TEYs), with durations shown, in order of increasing duration:

VMLUX: 2.66%, 2.5 years (limited term)

VWIUX: 3.02%, 4.7 (intermediate term)
VCADX: 3.12%, 4.8

VWLUX: 3.72%, 5.9 (long term)
VCLAX: 3.86%, 6.1

VWALX: 4.40%, 6.0 (high yield)

It's worth noting that the durations for the long-term funds understate the term risk due to call options on many of the bonds held by the funds.

Given that the yields for the CA and national funds of comparable duration are pretty close, you don't lose much by diversifying away from just holding CA munis--even less on a risk adjusted basis given the slightly shorter durations of the national funds.

One thing you could do is hold 50% the long-term CA fund and 50% in the limited-term national fund. This provides diversification among states and provides an overall intermediate-term duration.

Kevin
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kxl19
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Re: Muni guidance for $15m portfolio

Post by kxl19 » Sat Nov 09, 2019 8:33 pm

With that income, I'm guessing you're in the top fed and state tax brackets. If you want to hold bonds in taxable, it seems like a mix of treasuries and muni would be a good option, treasuries for the state tax exemption and muni for fed tax exemption.

I did some analysis on this topic before - for high state/fed tax bracket, it seems that a 50/50 portfolio of treasuries and munis give a higher tax equivalent yield, yet similar credit rating & duration as a typical total bond score.

I'd suggest VGIT or the MF equivalent for intermediate term treasuries, and then muni's either VWIUX (intermediate muni) or 50/50 VWIUX and VWALX (high yield muni).

Note: VWALX although a high yield muni, the credit rating is higher than a typical high-yield fund, and when mixed in with VGIT and VWIUX, the credit rating is similar to total bond.

For our taxable bond position, I'm doing this strategy
Last edited by kxl19 on Sat Nov 09, 2019 11:39 pm, edited 1 time in total.

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Kevin M
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Re: Muni guidance for $15m portfolio

Post by Kevin M » Sat Nov 09, 2019 9:58 pm

kxl19 wrote:
Sat Nov 09, 2019 8:33 pm
With that income, I'm guessing you're in the top fed and state tax brackets. If you want to hold bonds in taxable, it seems like a mix of treasuries and muni would be a good option, treasuries for the state tax exemption and muni for fed tax exemption.
OP gets fed and state tax exemption on the CA muni funds. But it's the TEYs that matter, not which tax exemptions you get.
kxl19 wrote:
Sat Nov 09, 2019 8:33 pm
I did some analysis on this topic before - for high state/fed tax bracket, it seems that a 50/50 portfolio of treasuries and munis give a higher tax equivalent yield, yet similar credit rating & duration as a typical total bond score.

I'd suggest VGIT or the MF equivalent for intermediate term treasuries, and then muni's either VWIUX (intermediate muni) or 50/50 VWIUX and VWALX (high yield muni).

Note: VWALX although a high yield muni, the credit rating is higher than a typical muni, and when mixed in with VGIT and VWIUX, the credit rating is similar to total bond.

For our taxable bond position, I'm doing this strategy
I would not use an intermediate-term Treasury fund at the highest fed and CA marginal tax rates and current yields.

Vanguard Intermediate-Term Treasury Index Fund Admiral Shares (VSIGX) has a TEY for OP (at assumed marginal tax rates stated in my last reply) of only 2.02% (SEC yield = 1.57%) with a duration of 5.2 years. The intermediate-term muni funds have 100 basis points or more higher TEY at 3.02% for Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) and 3.12% for Vanguard California Intermediate-Term Tax-Exempt Fund Admiral Shares (VCADX).

Even Vanguard Limited-Term Tax-Exempt Fund Admiral Shares (VMLUX) has a much higher TEY than the Treasury fund, at 2.66% (SEC yield = 1.41%), and with a much shorter duration at 2.5 years compared to 5.2 years for VSIGX.

Kevin
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kxl19
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Re: Muni guidance for $15m portfolio

Post by kxl19 » Sat Nov 09, 2019 11:38 pm

I would not use an intermediate-term Treasury fund at the highest fed and CA marginal tax rates and current yields.

Vanguard Intermediate-Term Treasury Index Fund Admiral Shares (VSIGX) has a TEY for OP (at assumed marginal tax rates stated in my last reply) of only 2.02% (SEC yield = 1.57%) with a duration of 5.2 years. The intermediate-term muni funds have 100 basis points or more higher TEY at 3.02% for Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) and 3.12% for Vanguard California Intermediate-Term Tax-Exempt Fund Admiral Shares (VCADX).

Even Vanguard Limited-Term Tax-Exempt Fund Admiral Shares (VMLUX) has a much higher TEY than the Treasury fund, at 2.66% (SEC yield = 1.41%), and with a much shorter duration at 2.5 years compared to 5.2 years for VSIGX.
These are great points - from my perspective, it depends on what you're optimizing for. If for yield, I'd agree the two above are better. However, some may have concerns of holding muni as the exclusive bond position, and if optimizing for credit risk to be similar to a Total Bond fund, mixing treasuries + muni would replicate the credit risk, but at a cost to yield. (but still better than a regular total bond fund at that bracket)

FYI - I've really enjoyed reading your posts (Kevin M), and have learned a ton from them. We've implemented a lot of your advice around optimizing holdings for TEY this year.

jory1804
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Re: Muni guidance for $15m portfolio

Post by jory1804 » Sun Nov 10, 2019 1:07 pm

I'm in a similar boat as you. Late 30s, low 8-figure NW, living in NYC where taxes are high.


For my bond allocation in taxable, I was previously 50:50 in treasuries:munis. More recently I've decided I prefer to be 100% in treasuries. The reason is that if you've already "won" the game, the only thing that can really get you is a terrible market scenario. And in such a scenario, the asset I want to be holding is treasuries.

More quantitatively, I find that treasuries have lower correlation with equity markets than do munis. Specifically, if I look at daily returns since 1991, treasuries are -21% correlated with equities, whereas munis are -4% correlated. A spreadsheet which demonstrates this is here.

Interesting, that same spreadsheet shows the returns to treasuries are actually higher than the return to munis since 1991. These are for funds of nearly equivalent duration. How can that be? Don't munis have higher yield? They do, but keep in mind that munis will experience some defaults, and are also often callable. Both of these characteristics will degrade the actual yield you receive.

Finally, I see munis as more vulnerable to tax law changes than treasuries. In particular, munis tend to be held by "rich people," and lawmakers might think these folks can "afford to take a haircut" as part of future tax reform. While this is admittedly unlikely, it is still possible.

You might not agree with all of the above, but just some things to think about...


I would probably avoid trying to choose a duration (i.e. short/medium/long) based on where rates are / where they might go. This sounds analogous to market timing in equities, which is an unloved activity here on Bogleheads.


You didn't ask about this, but in your tax advantaged account, I would recommend corporates. The reason being that corporates have the poorest tax treatment, for which you're compensated by getting the highest yield. And in a tax-advantaged account, the poor tax treatment doesn't affect you. Correspondingly, the favorable tax treatment of treasuries and munis is lost in a tax-advantaged account.


On your unappreciated gains: I would probably *not* recommend realizing those simply to shift your asset allocation. If you shift into munis, it will take over a decade to recoup the capital gains tax bill. The cheaper alternative is (of course) to shift your asset allocation over time using future income.

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Re: Muni guidance for $15m portfolio

Post by Artsdoctor » Sun Nov 10, 2019 1:14 pm

Two points. One, trying to figure out what interest rates will do is a fool's errand. Two, you're so young that you can absorb some of the shocks inherent to funds with longer (not really long) duration.

You can easily use the California fund and the national fund, with maturities up to you. If interest rates increase, you can easily switch out shares with losses and tax-loss harvest (California will let you carryover losses like the federal government). You can start with two intermediate-terms and then switch to a limited-term depending on your losses, and my personal preference is to stay with intermediate and limited term funds (and forego the long, but that's just personal preference). Use specific lots and read up on wash sale rules, but there are plenty of ways to handle this.

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Kevin M
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Re: Muni guidance for $15m portfolio

Post by Kevin M » Sun Nov 10, 2019 2:09 pm

jory1804 wrote:
Sun Nov 10, 2019 1:07 pm
For my bond allocation in taxable, I was previously 50:50 in treasuries:munis. More recently I've decided I prefer to be 100% in treasuries. The reason is that if you've already "won" the game, the only thing that can really get you is a terrible market scenario. And in such a scenario, the asset I want to be holding is treasuries.
Have you looked at the "terrible market scenario" of the late 1970s--in real terms? For the 5-year period 1977-1981 (inclusive), nominal intermediate-term Treasuries lost about 30% of their purchasing power and the S&P 500 lost about 8.5% of it's purchasing power. I'm not suggesting that munis would have been preferable during that period--just that Treasuries aren't immune to bad spells--even when stocks are doing poorly.
jory1804 wrote:
Sun Nov 10, 2019 1:07 pm
More quantitatively, I find that treasuries have lower correlation with equity markets than do munis. Specifically, if I look at daily returns since 1991, treasuries are -21% correlated with equities, whereas munis are -4% correlated. A spreadsheet which demonstrates this is here.
This might be so, but daily correlations don't matter much unless you're rebalancing daily. And for correlation periods that might line up more with a rebalancing schedule, you have to weigh the lower TEYs of the Treasuries against any superior rebalancing bonus you might achieve. When I've looked at this for good CDs, with significant yield premiums over Treasuries, the higher yields of the CDs outweighed the rebalancing bonus of Treasuries (with stocks).
jory1804 wrote:
Sun Nov 10, 2019 1:07 pm
Interesting, that same spreadsheet shows the returns to treasuries are actually higher than the return to munis since 1991. These are for funds of nearly equivalent duration.
Those returns don't factor in the tax exemption of the munis--kind of an important aspect to consider. And the time period matters--just glancing at the Vanguard funds list page, the 10-year returns of the muni funds was higher than the 10-year return of the intermediate-term Treasury fund, even not considering tax factors.
jory1804 wrote:
Sun Nov 10, 2019 1:07 pm
Finally, I see munis as more vulnerable to tax law changes than treasuries. In particular, munis tend to be held by "rich people," and lawmakers might think these folks can "afford to take a haircut" as part of future tax reform. While this is admittedly unlikely, it is still possible.
This is good to keep in mind.
jory1804 wrote:
Sun Nov 10, 2019 1:07 pm
You didn't ask about this, but in your tax advantaged account, I would recommend corporates. The reason being that corporates have the poorest tax treatment, for which you're compensated by getting the highest yield. And in a tax-advantaged account, the poor tax treatment doesn't affect you. Correspondingly, the favorable tax treatment of treasuries and munis is lost in a tax-advantaged account.
Or, one might consider holding TIPS in tax advantaged, if possible. TIPS also have issues in taxable, more so for individual TIPS than for a fund, and they hedge your portfolio against a late 1970s type scenario.

Kevin
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crossroads
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Re: Muni guidance for $15m portfolio

Post by crossroads » Mon Nov 11, 2019 2:53 pm

Thanks for all the feedback. Kevin, how were you calculating TEYs? I plugged the SEC yields into a few different online calculators but couldn't get the same numbers. Obviously my mistake, but still not sure where.

Also, I was mistaken in thinking I could get access to admiral shares from a non-Vanguard, refi-discount-driven brokerage account. I'll probably end up opening a Vanguard account when we close, but for now am thinking of low fee ETFs to accomplish something similar.

Taxable:
33% VGIT (Intermediate-Term Treasury ETF, 0.07 fee)
33% SUB (Short-Term National Muni Bond ETF, 0.07 fee)
33% VTEB (Tax-Exempt Bond ETF, 0.08 fee)

Will be open to CA funds (and longer terms) once I shed my single stock position, but being all munis seemed like undue risk given the rest of my portfolio.

And in tax advantaged, splitting 50/50 mostly because I can't decide how much TIPS exposure I want.
50% VTIP (Short-Term Inflation-Protected Securities ETF, 0.06 fee)
50% VCIT (Intermediate-Term Corporate Bond ETF, 0.07 fee)

Any obvious concerns with this?

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Re: Muni guidance for $15m portfolio

Post by Kevin M » Mon Nov 11, 2019 3:46 pm

crossroads wrote:
Mon Nov 11, 2019 2:53 pm
Thanks for all the feedback. Kevin, how were you calculating TEYs? I plugged the SEC yields into a few different online calculators but couldn't get the same numbers. Obviously my mistake, but still not sure where.
Formulas derived in this post: Taxable Equivalent Yield (TEY).

Many of the calculators assume state income tax is deducted on federal Schedule A, or calculate some other number that is really not generic TEY. I also derive the formula for the case of state income tax being deducted on marginal income in the linked post, but this is not common now, due to high standard deduction and $10K SALT limit on deductions; the latter probably applies to you, so you don't get a state income tax deduction on marginal income, and it's the marginal income that matters in determining marginal tax rates.
crossroads wrote:
Mon Nov 11, 2019 2:53 pm
Taxable:
33% VGIT (Intermediate-Term Treasury ETF, 0.07 fee)
33% SUB (Short-Term National Muni Bond ETF, 0.07 fee)
33% VTEB (Tax-Exempt Bond ETF, 0.08 fee)

Will be open to CA funds (and longer terms) once I shed my single stock position, but being all munis seemed like undue risk given the rest of my portfolio.

And in tax advantaged, splitting 50/50 mostly because I can't decide how much TIPS exposure I want.
50% VTIP (Short-Term Inflation-Protected Securities ETF, 0.06 fee)
50% VCIT (Intermediate-Term Corporate Bond ETF, 0.07 fee)

Any obvious concerns with this?
Not optimal from a TEY perspective, but it certainly gives you reasonable fixed income diversification. Some Treasuries for possible rebalancing with stocks in a big stock downturn (assuming flight to safety increases Treasury yields), some munis for higher TEY and with average short duration, some TIPS for inflation hedge, and some corporates for exposure to credit risk with correspondingly higher yields, with more tax-efficient bonds in taxable, and less tax-efficient in tax-advantaged.

Kevin
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Re: Muni guidance for $15m portfolio

Post by grabiner » Tue Nov 12, 2019 10:35 pm

I would suggest paying down the mortgage to $1M (or $750K if the mortgage was taken out too late to be grandfathered into the $1M rule). That is a risk-free return, and it is not deductible from federal tax, so it is probably a better return than you can get on munis. In your high tax bracket, a reasonable-rate mortgage which is fully deductible is at a very low rate, so it does make sense to buy munis rather than paying it down any further.
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sfmurph
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Re: Muni guidance for $15m portfolio

Post by sfmurph » Tue Nov 12, 2019 11:54 pm

Any thoughts on using a closed-end fund for muni funds? As active funds, the expense ratios are high and they use leverage, but that is used to increase the yield. Not for all bonds in AA, of course, but another product to consider.

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