Municipal bonds vs cash/CDs

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
marky2kk
Posts: 37
Joined: Tue Feb 11, 2020 10:53 am

Municipal bonds vs cash/CDs

Post by marky2kk » Tue Feb 11, 2020 11:24 am

I am fairly new to the U.S. and deciding whether to shift away from cash/CDs into Munis.

Background: I am 31, single, have a safe job, basically all my wealth is in taxable account, my asset allocation is 60% stocks, 10% in something less risky than stocks but more risky than cash/CDs/treasuries, and 30% in CDs and cash. Total assets are around 3.7 mil USD.

For the 10% intermediate risk portion, I currently hold 50% in LEMB, 25% in HYD, and 25% in MUB. The 30% risk-free portion is mostly a CD latter, with 10% in cash/savings accounts.

I am trying to decide whether to move some money from CDs/cash to MUB (or the safer BMBIX) given my tax situation and given that the illiquidity premium for CDs seems small. I realize Munis are more risky, but perhaps the additional yield is worth the risk. I am trying to figure out how much additional yield I get.

My tax situation is as follows: My annual labor income is around 220k (+dividends from stocks?), so as a single filer I should be in the 35% federal tax bracket. I live in DC and according to this website https://smartasset.com/taxes/income-taxes#PPYKmcwC1d that means my marginal tax rate is 35% (federal) + 8.5% (state) + 2.35% (FICA) for a whopping 45.85%... which seems quite large to me?!

I can calculate my after tax-return if I invest in a Capital One 360 Savings account (1.7%): 1.7*(1-0.4585) = 0.92055%

I am struggling to calculate my after tax return if I invest in MUB: MUB's average YTM is around 1.4% (all of which is tax-free?), the management fee is 7bps, for an after tax-yield of 1.33%? Or do I look at the distribution yield, which is 2.38%?

Now, MUB is clearly riskier than the savings account. Perhaps, BMBIX (with almost 100% triple A rated bonds) is a more proper comparison to the savings account. BMBIX has a 1.29% SEC yield, take away the 30bps expense ratio, and it's at 0.99%, slightly better than the savings account. But again, I am not sure whether 1.29% is the proper after-tax yield for the Muni bond ETF.

sycamore
Posts: 676
Joined: Tue May 08, 2018 12:06 pm

Re: Municipal bonds vs cash/CDs

Post by sycamore » Tue Feb 11, 2020 2:50 pm

marky2kk wrote:
Tue Feb 11, 2020 11:24 am
I am fairly new to the U.S. and deciding whether to shift away from cash/CDs into Munis.

Background: I am 31, single, have a safe job, basically all my wealth is in taxable account, my asset allocation is 60% stocks, 10% in something less risky than stocks but more risky than cash/CDs/treasuries, and 30% in CDs and cash. Total assets are around 3.7 mil USD.

For the 10% intermediate risk portion, I currently hold 50% in LEMB, 25% in HYD, and 25% in MUB. The 30% risk-free portion is mostly a CD latter, with 10% in cash/savings accounts.

I am trying to decide whether to move some money from CDs/cash to MUB (or the safer BMBIX) given my tax situation and given that the illiquidity premium for CDs seems small. I realize Munis are more risky, but perhaps the additional yield is worth the risk. I am trying to figure out how much additional yield I get.

My tax situation is as follows: My annual labor income is around 220k (+dividends from stocks?), so as a single filer I should be in the 35% federal tax bracket. I live in DC and according to this website https://smartasset.com/taxes/income-taxes#PPYKmcwC1d that means my marginal tax rate is 35% (federal) + 8.5% (state) + 2.35% (FICA) for a whopping 45.85%... which seems quite large to me?!

I can calculate my after tax-return if I invest in a Capital One 360 Savings account (1.7%): 1.7*(1-0.4585) = 0.92055%

I am struggling to calculate my after tax return if I invest in MUB: MUB's average YTM is around 1.4% (all of which is tax-free?), the management fee is 7bps, for an after tax-yield of 1.33%? Or do I look at the distribution yield, which is 2.38%?

Now, MUB is clearly riskier than the savings account. Perhaps, BMBIX (with almost 100% triple A rated bonds) is a more proper comparison to the savings account. BMBIX has a 1.29% SEC yield, take away the 30bps expense ratio, and it's at 0.99%, slightly better than the savings account. But again, I am not sure whether 1.29% is the proper after-tax yield for the Muni bond ETF.
marky2kk,

"a whopping 45.85%... which seems quite large to me?!" - yeah, sounds quite large to me, too! Condolences, but congrats for making so much in the first place :)

You won't incur federal income taxes on MUB dividends, but you will owe state/DC taxes on them so take that into account.

Distribution yield tells you what happened in the past, SEC yield has a specific definition, but it's often used to estimate the forward-looking yield. Most people use SEC yield when comparing after-tax yield of differing investments.

Both BMBIX and MUB are "riskier" in several ways than a savings account. They have day-to-day NAV ups and downs. They have risk of some of the underlying bonds going bust. But they're not "junk" bond risky (although some people are rather worried about a few of the states' obligations, especially Illinois and the like). I use VWIUX which is similar enough to MUB.

Don't subtract the 30bps expense ratio from the SEC yield; the ER is already accounted for.

You're the classic case for using a municipal bond fund (over a taxable bond fund) because of your high tax bracket. But whether to use muni bond over a savings account or CDs is a slightly different question. I'd spend some time checking out https://www.depositaccounts.com/blog/ for the latest in rates. Depending on how much time you want to spend researching rates and switching your cash/CDs around, you may find it's worth the effort if you get a good rate. From what I read, you need some patience and willingness to jump on some of the CD offers.

Good luck!

Topic Author
marky2kk
Posts: 37
Joined: Tue Feb 11, 2020 10:53 am

Re: Municipal bonds vs cash/CDs

Post by marky2kk » Tue Feb 11, 2020 4:07 pm

Thanks! Are you sure that I have to pay state taxes on Muni bonds? I think I don't have to, see here https://www.municipalbonds.com/tax-educ ... ome-taxes/

"Our capital’s district does not tax in-state or out-of-state municipal bonds. This means Washington D.C. residents can buy bonds from anywhere and not pay state or district income taxes on the interest."

So, my pre tax-equivalent yield for the MUB (SEC yield at 1.38% right now) would be 1.38/(1-0.4585) = 2.54%.
You're the classic case for using a municipal bond fund (over a taxable bond fund) because of your high tax bracket. But whether to use muni bond over a savings account or CDs is a slightly different question.
You are absolutely right about that! In fact, I do not own any taxable bonds (except LEMB, but that thing behaves more like a stock). My main concern right now is that I do not want to succumb to making my portfolio riskier by reaching for yield because CDs and Munis are not the same animals. So a compromise could be to choose a very safe Muni ETF and classify that ETF into the 30% risk-free part of my portfolio.

Particularly, I am looking at BIMBX (factsheet here: https://content.rwbaird.com/BairdFunds/ ... -sheet.pdf)

The institutional class has an SEC yield of 1.29% today if I am not mistaken.. with 70% in AAA. I also just found this thread, which seems to include the comparisons that I am looking for:

viewtopic.php?t=273984

deikel
Posts: 1069
Joined: Sat Jan 25, 2014 7:13 pm

Re: Municipal bonds vs cash/CDs

Post by deikel » Tue Feb 11, 2020 4:21 pm

Personally I would not bother.

Yes, you save some taxes on the muni bond return - but the return is low to begin with.

So, even if you save the 40% taxes on their return (of only 1.4 %), so you save like 0.5% on what value ?

Say you have 50k in muni bonds (is it that much?) - you save a whopping 250 USD per year in taxes.

Not that 250 USD is not some money, but given your income, I think there are other ways to get to 250 USD saved with less complication to your portfolio.
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.

sycamore
Posts: 676
Joined: Tue May 08, 2018 12:06 pm

Re: Municipal bonds vs cash/CDs

Post by sycamore » Tue Feb 11, 2020 4:37 pm

marky2kk wrote:
Tue Feb 11, 2020 4:07 pm
Thanks! Are you sure that I have to pay state taxes on Muni bonds? I think I don't have to, see here https://www.municipalbonds.com/tax-educ ... ome-taxes/

"Our capital’s district does not tax in-state or out-of-state municipal bonds. This means Washington D.C. residents can buy bonds from anywhere and not pay state or district income taxes on the interest."
Looks like you don't pay DC taxes on Muni bonds -- I wrongly assumed DC was like the States in terms of muni bond tax treatment. That works out better for you.
marky2kk wrote:
Tue Feb 11, 2020 4:07 pm
... My main concern right now is that I do not want to succumb to making my portfolio riskier by reaching for yield because CDs and Munis are not the same animals. So a compromise could be to choose a very safe Muni ETF and classify that ETF into the 30% risk-free part of my portfolio.
...
That fund looks rather safe, and it dropped less during the 2008-2009 than VWITX or MUB did.

I wouldn't classify it as purely"risk-free". One risk is if its duration of around 4.25 years exceeds your investment horizon. If you're holding for longer than that, it's a fine choice.

Topic Author
marky2kk
Posts: 37
Joined: Tue Feb 11, 2020 10:53 am

Re: Municipal bonds vs cash/CDs

Post by marky2kk » Wed Feb 12, 2020 3:53 pm

deikel wrote:
Tue Feb 11, 2020 4:21 pm
Personally I would not bother.

Yes, you save some taxes on the muni bond return - but the return is low to begin with.

So, even if you save the 40% taxes on their return (of only 1.4 %), so you save like 0.5% on what value ?

Say you have 50k in muni bonds (is it that much?) - you save a whopping 250 USD per year in taxes.

Not that 250 USD is not some money, but given your income, I think there are other ways to get to 250 USD saved with less complication to your portfolio.
Yes, that's a valid point. I thought about it and I think here is what I will do:

Stay the course and keep 30% risk-free, i.e. do not mix Munis in that part of my portfolio. Instead shift some money around in the 10% part of my portfolio that is less risky than equities but not risk-free. That is, I am going to disinvest LEMB and put that money into HYD. HYD has an SEC yield of 3.05%, so the pre-tax equivalent would be around 5.5% for me. That's larger than the SEC yield on LEMB, which is around 5%.. and HYD has a standard deviation of only around 3% compared with LEMB's 10% standard deviation.

ofckrupke
Posts: 746
Joined: Mon Jan 10, 2011 2:26 pm

Re: Municipal bonds vs cash/CDs

Post by ofckrupke » Wed Feb 12, 2020 4:33 pm

A side note is that the medicare tax rate (1.45%, + 0.9% for subject income above 200k single/250k mfj) only applies to labor income.
The relevant high-income surtax for this topic is the Net Investment Income tax; NII above AGI 200k/250k is surtaxed at 3.8%.
That doesn't change the numbers calculated upthread by much, but the conceptual/procedural distinction is important.

hudson
Posts: 2885
Joined: Fri Apr 06, 2007 9:15 am

Re: Municipal bonds vs cash/CDs

Post by hudson » Wed Feb 12, 2020 5:06 pm

marky2kk,
Consider doing the math in dollars and not in percentages.
Compare say a 3% 5 year CD to the distribution yield of MUB, VWIUX, and BMBIX...after taxes.
As you know distribution yield is what is paid out monthly.
I'm roughly 75% CDs and 25% VWIUX....so I go with both.
When I do the math on a spreadsheet VWIUX always distributes more dollars monthly than the 3% CDs...after taxes.
The CDs always win the safety comparison.
I agree with others that the ER is already subtracted before the SEC Yield and Distribution Yield are published.

Topic Author
marky2kk
Posts: 37
Joined: Tue Feb 11, 2020 10:53 am

Re: Municipal bonds vs cash/CDs

Post by marky2kk » Thu Feb 20, 2020 1:46 pm

I sold 90k of LEMB and was thinking to put that money into HYD. Now I am scratching my head around the following:

In principle, my investment horizon is several decades. However, there is a 75% chance that I will leave the U.S. (and not be taxable) within the next 3-5 years. I am not a U.S. citizen.

If I leave the U.S, the muni bonds lose their tax advantage and presumably my new country of residence just taxes munis regularly. Clearly, in that case I would be better off holding taxable bonds. So even though my investment horizon is long in general, for munis it is rather short given that I expect to leave the U.S. at some point?

So I am thinking SHYD with a much lower duration than HYD is perhaps a better choice given these personal circumstances?

hudson
Posts: 2885
Joined: Fri Apr 06, 2007 9:15 am

Re: Municipal bonds vs cash/CDs

Post by hudson » Thu Feb 20, 2020 1:56 pm

marky2kk wrote:
Thu Feb 20, 2020 1:46 pm
I sold 90k of LEMB and was thinking to put that money into HYD. Now I am scratching my head around the following:

In principle, my investment horizon is several decades. However, there is a 75% chance that I will leave the U.S. (and not be taxable) within the next 3-5 years. I am not a U.S. citizen.

If I leave the U.S, the muni bonds lose their tax advantage and presumably my new country of residence just taxes munis regularly. Clearly, in that case I would be better off holding taxable bonds. So even though my investment horizon is long in general, for munis it is rather short given that I expect to leave the U.S. at some point?

So I am thinking SHYD with a much lower duration than HYD is perhaps a better choice given these personal circumstances?
I can't speak to moving out of the US; there are those that can.
If or when you leave the US couldn't you just sell the muni fund or etf? You might have a gain or a loss...but you always have a gain or a loss anyway.

Topic Author
marky2kk
Posts: 37
Joined: Tue Feb 11, 2020 10:53 am

Re: Municipal bonds vs cash/CDs

Post by marky2kk » Thu Feb 20, 2020 2:16 pm

That's right, but "having a gain or a loss" is a risk as it introduces variance into the payoff when I leave the U.S., right? It would be better to have no risk, i.e. zero gain or loss with approximate certainty, which happens when the investment horizon is equal to the duration.

So that's my thought for SHYD, which matches my investment horizon for munis better than the other long-duration muni ETFs.

hudson
Posts: 2885
Joined: Fri Apr 06, 2007 9:15 am

Re: Municipal bonds vs cash/CDs

Post by hudson » Thu Feb 20, 2020 4:28 pm

marky2kk,

SHYD is a short term ETF but it has 2 issues. Expenses are high and the portfolio holds too many risky bonds. I wouldn't touch it with a 10 foot pole.
I would want an ETF like MUB or VTEB with a high percentage of AAA/AA bonds and a low expense ratio.

All 3 ETFs can have losses or gains.

As you already know, a zero loss/gain product would be a CD.

Post Reply