Switch to Munis in Taxable Account?

[yej84]

Hi everyone,

This is my first post on Bogleheads. I've really enjoyed reading the forum, and hope the community can help with a few Muni questions.

Quick summary of my portfolio:

-- I'm 37, with a 401k, Roth IRA, and Taxable account.
-- Hoping to retire early at around age 50.
-- Retirement accounts are nearly 100% stocks.
-- Taxable account is 77% stocks / 23% bonds, consisting of:

• Total Stock Market Index Adm (VTSAX) - 50%

• Total International Stock Index Adm (VTIAX) - 27%

• Total Bond Market Index Adm (VBTLX) - 23%

-- I recently moved up to the 32% tax bracket, and live in California (9.3% bracket).

I'm now wondering whether it's time to switch my Taxable bonds to a Muni fund. I know some people here would say my bonds should all be in my Retirement accounts instead of Taxable. But I don't intend to touch my Retirement accounts for many decades, while my Taxable account is for a mixture of short, medium, and long-term goals. Hence, why I decided to put some bonds in there.

With that out of the way, here are my questions:

1) At what tax bracket does it make sense to switch from Taxable bonds to Muni bonds? I've used a tax-equivalent calculator, but sometimes it says Muni bonds are better, and other times it says Taxable bonds are better. Is there a general rule of thumb on the matter? Should someone in the 32% tax bracket always go with Munis?

2) If I were to switch to Munis, I'd need to replace Total Bond Market. I'm considering two Muni funds:

• Intermediate-Term Tax-Exempt Adm (VWIUX)

• Tax-Exempt Bond Index Adm (VTEAX)

Does one of these funds make more sense as a core Muni holding? Which one would more closely approximate Total Bond Market?

3) Finally, even if I determine that Munis make more sense from a tax perspective, am I giving up the ballast and diversification benefits of Total Bond Market? Compared to Munis, I've read that Taxable bonds are less correlated with stocks and may provide better protection during market drops. So, is there an argument for ignoring Munis and sticking with Total Bond Market, even if I'm now in the 32% bracket?

Thanks for any and all thoughts on my situation!

[retired@50]

1)... Should someone in the 32% tax bracket always go with Munis?

2) If I were to switch to Munis, I'd need to replace Total Bond Market. I'm considering two Muni funds:

• Intermediate-Term Tax-Exempt Adm (VWIUX)

• Tax-Exempt Bond Index Adm (VTEAX)

Does one of these funds make more sense as a core Muni holding? Which one would more closely approximate Total Bond Market?

3) Finally, even if I determine that Munis make more sense from a tax perspective, am I giving up the ballast and diversification benefits of Total Bond Market? Compared to Munis, I've read that Taxable bonds are less correlated with stocks and may provide better protection during market drops. So, is there an argument for ignoring Munis and sticking with Total Bond Market, even if I'm now in the 32% bracket?

Thanks for any and all thoughts on my situation!

Welcome to the forum.

1. Probably, and certainly if you're in a high tax state. What state are you in?

2. The two funds you are considering are good ones. I think the VTEAX fund is closer to the total bond objective of holding all maturities, etc.

3. I think you should probably reconsider the 100% stock idea in the retirement accounts. By devoting some retirement account space to taxable bond funds like total bond market, you'll gain diversification in your bond holdings (taxable bond funds in the retirement space, and municipal bonds in the taxable space), and you'll gain some tax efficiency. Holding taxable bonds in a taxable account at your tax bracket is likely sub-optimal.

Edited to add:
At the moment, using VBTLX and VTEAX as taxable versus muni yields...
With VBTLX yielding 2.45% your after tax return is 1.66% when you consider the 32% Federal income tax.
With VTEAX yielding 1.99% your after tax return is 1.99%.

Regards,

[drk]

Need to know your state to say which muni fund, but I would probably just move some of your pre-tax 401k to bonds and your taxable to 100% stock instead.

I know some people here would say my bonds should all be in my Retirement accounts instead of Taxable. But I don't intend to touch my Retirement accounts for many decades, while my Taxable account is for a mixture of short, medium, and long-term goals. Hence, why I decided to put some bonds in there.

This rationale doesn't make sense. If you need money in taxable, you can use two steps to free it up without selling stocks:

1. Exchange $X bonds for stocks in 401k
2. Sell $X stocks in taxable

There's a section of the Tax-Efficient Fund Placement dedicated wiki page about this if you want to read more, but it's really that simple.

[yej84]

Thanks, drk and retired@50! I live in California (and have edited my original post to reflect this).

This rationale doesn't make sense. If you need money in taxable, you can use two steps to free it up without selling stocks:

1. Exchange $X bonds for stocks in 401k
2. Sell $X stocks in taxable

drk, I've heard of this approach. But I should add that I'm hoping to retire early (at age 50), so will need to live off my Taxable account for at least a decade (preferably two decades) before tapping my Retirement accounts. With that in mind, I thought it made sense for my Retirement accounts to be nearly 100% stocks -- giving them the best chance to grow since I won't be touching that money for so long.

Also, I like the idea of having some bonds in my Taxable so I'm not forced to sell stocks when they're low just because I need the money at that time.

But I'm still debating all this in my head. I'm happy to be shown a better way... just wanted to at least explain my rationale!

[drk]

Since you live in CA, any muni allocation should include some a CA muni fund (VCAIX/VCADX at Vanguard, it looks like?). Otherwise, you'll get lower bond income without getting the full tax benefit.

drk, I've heard of this approach. But I should add that I'm hoping to retire early (at age 50), so will need to live off my Taxable account for at least a decade (preferably two decades) before tapping my Retirement accounts. With that in mind, I thought it made sense for my Retirement accounts to be nearly 100% stocks -- giving them the best chance to grow since I won't be touching that money for so long.

Your stock funds will grow the same either way, so it makes sense to place them wherever they're most tax-efficient. It may make sense to put your bonds in taxable, but I don't think this is a compelling reason to do it.

BTW, you should know how to access retirement funds early so that you don't feel constrained to just using taxable accounts for spending needs.

Also, I like the idea of having some bonds in my Taxable so I'm not forced to sell stocks when they're low just because I need the money at that time.

Check out the wiki page I linked above. Using the two-step maneuver I described, if you're selling low in taxable, you would also be buying low in tax-advantaged.

[retired@50]

Thanks, drk and retired@50! I live in California (and have edited my original post to reflect this).

In that case, you should check out the Vanguard CA intermediate tax-exempt muni fund VCAIX or its Admiral share class VCADX if you have over $50,000 to invest.

Also, if you want longer term bond exposure, you can consider using the Vanguard CA Long term tax-exempt muni fund VCITX or its Admiral share class VCLAX if you have over $50,000 to invest.

Avoiding the additional taxation on CA income taxes will provide an additional benefit.

Regards,

[dratkinson]

This has been recommended for CA residents.
--50% VCITX/VCLAX (CA long term muni bond fund/admiral)
--50% VMLTX/VMLUX (limited term national muni fund/admiral)

Why?
--The pairing gives intermediate term (IT) bond duration, which is on recommended sweet spot of bond risk/reward yield curve.
--Reduces your single-state default risk*. (* Think 1994 Orange County default.)
--Exempts most of your muni dividends from fed/CA tax.
--Both are daily-accrual funds, so don't need to worry about IRS 6mos holding period requirement to protect TE (tax-exempt) dividends. (VTEAX is monthly-accrual, IRS 6mo holding period requirement applies to shares owned to protect TE dividends.)
See "Loss on mutual fund shares held 6 months or less": https://www.bogleheads.org/wiki/Tax_los ... harvesting

Daily-accrual munis mean you can immediately sell shares to use as an extension of your 1st-tier EFs (emergency funds: checking, savings, CDs,…) and not worry about losing TE dividend status.

Assuming you have minimal* gains in VBTLX, then there will be little CG (capital gains) tax owed to switch from taxable to muni bonds. (* You can thank the current market for this gift.)


Muni TEY (taxable-equivalent yield) calculation.
--National muni TEY = muni SEC yield / (1 – fed tax bracket).
--Single-state muni TEY = muni SEC yield / (1 – fed tax bracket – state tax bracket). (A slightly different calculation applies if you deduct state tax on fed tax return; can’t immediately find it.)

Example.
--VBTLX SEC yield = 2.45%
--VCITX TEY = 2.19% / (1 - .32 - .093) = 3.61% 3.731%
--VMLTX TEY = 1.29% / (1 - .32) = 1.90%

A 50/50 pairing of munis should produce TEY of 2.815% (=(3.731+1.9)/2).

But, the simple TEY calculation (a first look at muni goodness) misses the fact that, if TE dividends reduce your income enough, you might drop into a lower tax bracket, and thereby benefit all of your income. This effect can only be seen by producing sample tax returns (a second look at muni goodness).


Recommendations.
--Roth IRA. To maximize growth, use all stock funds, that don't impede your ability to TLH (tax-loss harvest).
Read all of above linked TLHing topic.
--401k (assumed to be traditional/tax-deferred). Use all-in-one fund for simplicity. It will take care of its bonds for you.
--Taxable. Use TSM (total stock market), TISM (total international stock market), and muni bonds. To avoid TLH problems, redirect all distributions to savings/mmkt to control when "replacement shares" are purchased.

Above means:
--You only need to tweak your bonds in taxable to give your desired AA (asset allocation) to bonds.
--You can TLH when the market allows.
--With muni TE dividends and TLHing in some years, you might drop into lower tax brackets in those years.
--You can use your munis as an extended-tier EF, and not worry about losing TE dividend status.


Welcome.


Edit. Oops.

[grabiner]

You should definitely prefer munis to taxable bonds in your taxable account, since you pay no tax on CA munis, only 9.3% on non-CA munis, and 45.1% on taxable bonds (32% federal + 9.3% CA + 3.8% NIIT).

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

[moontower]

Look at PCQ for CA muni bond fund (PIMCO) - its the best and blows Vanguard returns away for CA tax exempt bonds....

[GreendaleCC]

Look at PCQ for CA muni bond fund (PIMCO) - its the best and blows Vanguard returns away for CA tax exempt bonds....

Hard pass. You are comparing apples to oranges.

PCQ's expense ratio is 1.44% vs the Vanguard funds' 0.17% (Investor) and 0.09% (Admiral).

PCQ's duration is 12.61 years vs the Vanguard funds' 4.4 years (CA Intermediate-term) and 5.5 years (CA Long-term).

VCAIX YTD -6.07%
VCITX YTD -7.41%
PCQ YTD -15.50%

PIMCO reports that PCQ is priced at a 27.64% premium to NAV.

[grabiner]

Look at PCQ for CA muni bond fund (PIMCO) - its the best and blows Vanguard returns away for CA tax exempt bonds....

PCQ is leveraged, so it doubles the risk in order to get double the pre-expense return. You could get the same effect by buying twice as much of an unleveraged fund and borrowing half that amount, and probably do better since the PIMCO fund has 1.20% expenses.

The leverage is the reason that it blows returns away, both up and down; it is down twice as much as Vanguard CA Long-Term Tax-Exempt year to date. And the leverage also causes it to do a poor job of risk mitigation; it lost almost as much as the stock market in the March 2020 crash.

[yej84]

In that case, you should check out the Vanguard CA intermediate tax-exempt muni fund VCAIX or its Admiral share class VCADX if you have over $50,000 to invest.

If I wanted to keep things simple, could Vanguard CA Intermediate-Term Tax-Exempt (VCADX) work as the only bond fund in my Taxable account? Is the CA muni market big enough and diversified enough to serve as my core bond holding? Thanks.

[retired@50]

In that case, you should check out the Vanguard CA intermediate tax-exempt muni fund VCAIX or its Admiral share class VCADX if you have over $50,000 to invest.

If I wanted to keep things simple, could Vanguard CA Intermediate-Term Tax-Exempt (VCADX) work as the only bond fund in my Taxable account? Is the CA muni market big enough and diversified enough to serve as my core bond holding? Thanks.

I would still use a taxable bond fund (like VBTLX total bond market) in the retirement accounts to help balance things out. Holding just state-specific municipal bonds as your only bond holding will leave you less diversified than you could or should be in my view.

I think the Vanguard CA muni fund (VCAIX) holds over 5,800 bonds, so it's certainly diversified within the state of CA, but not diversified when you consider the entire bond market.

I know you've expressed a distaste for holding some percentage of your retirement accounts in a taxable bond fund, but I really don't think that using something like VBTLX total bond market, in your retirement account will be something that will send your retirement plans off the rails.

Being a high tax bracket investor (as you are) means tax efficiency becomes more important. So, maybe review the tax efficient fund placement wiki page.
https://www.bogleheads.org/wiki/Tax-eff ... _placement

Regards,

[grok87]

You should definitely prefer munis to taxable bonds in your taxable account, since you pay no tax on CA munis, only 9.3% on non-CA munis, and 45.1% on taxable bonds (32% federal + 9.3% CA + 3.8% NIIT).

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

It’s a good point about the 3.8% NIIT but perhaps OP is not subject to that just yet- but may be soon?

[grok87]

You should definitely prefer munis to taxable bonds in your taxable account, since you pay no tax on CA munis, only 9.3% on non-CA munis, and 45.1% on taxable bonds (32% federal + 9.3% CA + 3.8% NIIT).

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

It’s a good point about the 3.8% NIIT but perhaps OP is not subject to that just yet- but may be soon?

[grok87]

Thanks, drk and retired@50! I live in California (and have edited my original post to reflect this).

This rationale doesn't make sense. If you need money in taxable, you can use two steps to free it up without selling stocks:

1. Exchange $X bonds for stocks in 401k
2. Sell $X stocks in taxable

drk, I've heard of this approach. But I should add that I'm hoping to retire early (at age 50), so will need to live off my Taxable account for at least a decade (preferably two decades) before tapping my Retirement accounts. With that in mind, I thought it made sense for my Retirement accounts to be nearly 100% stocks -- giving them the best chance to grow since I won't be touching that money for so long.

Also, I like the idea of having some bonds in my Taxable so I'm not forced to sell stocks when they're low just because I need the money at that time.

But I'm still debating all this in my head. I'm happy to be shown a better way... just wanted to at least explain my rationale!

Doesn’t drk’s idea make you pay taxes on your stock gains?

[grabiner]

Thanks, drk and retired@50! I live in California (and have edited my original post to reflect this).

This rationale doesn't make sense. If you need money in taxable, you can use two steps to free it up without selling stocks:

1. Exchange $X bonds for stocks in 401k
2. Sell $X stocks in taxable

drk, I've heard of this approach. But I should add that I'm hoping to retire early (at age 50), so will need to live off my Taxable account for at least a decade (preferably two decades) before tapping my Retirement accounts. With that in mind, I thought it made sense for my Retirement accounts to be nearly 100% stocks -- giving them the best chance to grow since I won't be touching that money for so long.

Also, I like the idea of having some bonds in my Taxable so I'm not forced to sell stocks when they're low just because I need the money at that time.

But I'm still debating all this in my head. I'm happy to be shown a better way... just wanted to at least explain my rationale!

Doesn’t drk’s idea make you pay taxes on your stock gains?

This does make you pay taxes on your stock gains, but these are taxes you would be paying eventually anyway, so they are not a total loss. In addition, you are likely to be selling stock you have bought recently, so the capital-gains tax on that stock will be relatively low.

Whether to hold bonds or stock in taxable depends on the total tax cost over your holding period, including both the dividend tax and the capital-gains tax when you eventually sell the stock. (If you hold munis, there is a hidden tax cost of about 1/3 of the yield, as that is the usual difference between the yields of taxable and muni bonds of comparable risk.) Thus, if muni yields are higher than stock yields, as they are now, the total tax cost of holding stocks in taxable tends to be lower.

But for the OP, who pays almost double the usual tax on stocks and no extra tax on CA munis, muni yields would have to be twice stock yields for the same break-even consideration. This is why I recommend CA munis in taxable.

It’s a good point about the 3.8% NIIT but perhaps OP is not subject to that just yet- but may be soon?

It's barely possible now for a single taxpayer (32% bracket begins at $170,050, NIIT at $200,000), but with inflation adjustments, it will be almost impossible in 2023 since the NIIT threshold is not indexed to inflation.

[dratkinson]

...
If I wanted to keep things simple, could Vanguard CA Intermediate-Term Tax-Exempt (VCADX) work as the only bond fund in my Taxable account? Is the CA muni market big enough and diversified enough to serve as my core bond holding? Thanks.

Reworking above.
--VBTLX (TBM IT Adm) SEC yield = 2.46%
--VCLAX (CA LT Adm) TEY = 2.28% / (1 - .32 - .093) = 3.88%
--VCADX (CA IT Adm) TEY = 1.91% / ( 1 -.32 - .093) = 3.25%
--VMLUX (Ltd term national Adm) TEY = 1.39% / (1 - .32) = 2.04%

50/50 pairing of VCLAX/VMLUX gives TEY of 2.96%, better than forum's 3-fund portfolio's recommended TBM (total US bond market index fund).


The IT duration and TEY suggest "Yes" for VCADX.

But CA is on the short list of "death spiral" states.
Search "death spiral state": https://www.google.com/search?q=death+spiral+states

So, that is worrying.
--Hence the recommendation to allocate no more that 50% of your taxable bonds to CA munis.
--The LT CA muni provides more yield, hence its recommendation as your 50% single-state part.
--VMLUX (Ltd term) is recommended to bring your total duration toward back toward IT.

To boost yield, I'd be comfortable replacing VMLUX with VWIUX (IT national muni Adm).


The SWAN (sleep well at night) test. We are advised to use investments that allow us to pass the SWAN test. This is a decision that only you can make.

In the absence of other information, I've always chosen to follow the forum's advice. And then, as my knowledge increased and I gained experience in managing my investments, I've only deviated from the forum's advice when I was able to tolerate the consequence of "being wrong".

I'd be really uncomfortable having all my munis in CA.

[grok87]

I'd be really uncomfortable having all my munis in CA.

agree. or any state

[yej84]

--Hence the recommendation to allocate no more that 50% of your taxable bonds to CA munis.
--The LT CA muni provides more yield, hence its recommendation as your 50% single-state part.
--VMLUX (Ltd term) is recommended to bring your total duration toward back toward IT.

To boost yield, I'd be comfortable replacing VMLUX with VWIUX (IT national muni Adm).

Thanks, dratkinson. This has been very helpful.

As much as I'd like to keep things simple and have only one muni fund, it sounds like living in California means I really should consider splitting my muni allocation between National and CA funds.

What if I split it 50/50 between:

Intermediate-Term Tax-Exempt (VWIUX)
California Intermediate-Term Tax-Exempt (VCADX)

Would this be similarly effective compared to your National Limited-Term muni & CA Long-Term muni solution?

[HMSVictory]

Gotta love California - beautiful State and man do they charge for it 9.3%! Wow!

You are at 41.3% marginal bracket between State and Feds. Gives BND an after tax return of 1.60 for you....

Now more importantly you have received a lot of very good feedback on where to keep the bonds above this post. You should keep the vast majority of the bonds in your retirement accounts! Why? Even if you are 100% VTI in your taxable account and you retire and sell VTI to fund your income. When you sell VTI in taxable (if its at a loss you gain a TLH benefit) then you immediately buy the same amount of VTI by selling BND in your retirement accounts. You maintain the same asset allocation and it doesn't matter if the market is down because you are buying the same amount you are selling.

Rob Berger on YouTube has covered this very extensively and I agree with his analysis.

I'm in a different boat because almost all of my retirement funds are Roth - so I keep all stock in them.

[grabiner]

As much as I'd like to keep things simple and have only one muni fund, it sounds like living in California means I really should consider splitting my muni allocation between National and CA funds.

What if I split it 50/50 between:

Intermediate-Term Tax-Exempt (VWIUX)
California Intermediate-Term Tax-Exempt (VCADX)

Would this be similarly effective compared to your National Limited-Term muni & CA Long-Term muni solution?

This is similar but slightly tax-inferior. If you use short-term national munis and long-term CA munis, more than half your muni income is exempt from CA tax. At current yields of 1.61% on Limited-Term Tax-Exempt and 2.56% on CA Long-Term Tax-Exempt, this saves you CA tax on 0.48% compared to an equal-duration split, which is 0.04% of your muni investment at a 9,3% tax rate; it could be more if the yield curve becomes steeper in the future.

[cacophony]

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

This would cause retirement accounts to likely grow a lot and taxable account to barely grow at all. In retirement, doesn't having a large taxable account become a significant tax advantage? You can get away with paying virtually zero taxes on long term gains, compared to retirements accounts that are typically taxed at ordinary income rates.

[dratkinson]

--Hence the recommendation to allocate no more that 50% of your taxable bonds to CA munis.
--The LT CA muni provides more yield, hence its recommendation as your 50% single-state part.
--VMLUX (Ltd term) is recommended to bring your total duration toward back toward IT.

To boost yield, I'd be comfortable replacing VMLUX with VWIUX (IT national muni Adm).

Thanks, dratkinson. This has been very helpful.

As much as I'd like to keep things simple and have only one muni fund, it sounds like living in California means I really should consider splitting my muni allocation between National and CA funds.

What if I split it 50/50 between:

Intermediate-Term Tax-Exempt (VWIUX)
California Intermediate-Term Tax-Exempt (VCADX)

Would this be similarly effective compared to your National Limited-Term muni & CA Long-Term muni solution?

Previously answered.

...
In the absence of other information, I've always chosen to follow the forum's advice. And then, as my knowledge increased and I gained experience in managing my investments, I've only deviated from the forum's advice when I was able to tolerate the consequence of "being wrong".

You are in the early phase of learning "What works for you?"

Interest rates have been lower the past ~2yrs (coincidental with covid), so existing (higher-yield) bond/fund prices have risen.

This trend seems to be reversing, meaning rising yields will cause existing bond/fund prices to drop. As you are still learning, you will not be happy when buy CA LT muni, and then see it's price drop.

On the other hand, you may wonder why ST and limited-term national muni prices don't drop as much? It's related to the duration (interest-rate sensitivity) of the underlying bonds in the funds---shorter durations are less sensitive to interest rate risk, longer durations are more sensitive.


Disclosure. I'm in the same boat. I have a TLH opportunity with VWLUX (LT national muni), because I've been buying it over the past 2yrs at the then higher prices. But in VWIUX (IT national muni) and my single-state muni, since I have NOT been buying them (was avoiding their lower yields), so my cost basis in both is lower than current prices---no TLH opportunity.

(Added) I'm in no rush to TLH as I expect this opportunity will exist, and improve throughout this year.


You need bonds. You don't want to fill your TA (tax-advantaged) space (retirement accounts) with bonds as that wastes space which could better be used to tax-shelter equity growth. So some of your bonds must be in taxable space. And in your tax brackets, that means using munis.

And with your use of a longer-duration muni (higher yield, higher interest rate sensitivity) and rising interest rates, that means you need learn to take advantage of your upcoming TLH opportunities. (The forum offers a free handholding service. Study the mechanics/gotchas of LTHing. Plan your TLH. Post your plan for review. We'll ensure you do it correctly. Easy peasy.)


Required student reading.
--Wiki topic: https://www.bogleheads.org/wiki/Tax_loss_harvesting
--Swedroe's bond book (public library): The Only Guide to a Winning Bond Strategy You'll Every Need.


Idea. Since I expect your TLH opportunity to be in LT CA muni, you could TLH your LT CA to your ST or limited-term national muni (your choice), and use new money to rebalance back to 50/50 (national/single-state) by buying more LT CA.

N.B. Timing will be critical in above to avoid buying replacement shares of LT CA within the 30day wash sale window. But it's doable, may only be required a few times, over the next few years, until interest rates stabilize... so easy enough to handle.


Are we having fun yet?


Sincerely.
--You must do *all* required reads to become an educated investor.
--You must use your new knowledge to manage your investments, thereby gaining experience.
--One of the things you must learn to and do, is how to TLH. Why? It's the only way to get over your fear (and see the opportunity) in market fluctuations.

Within 5yrs you'll be comfortable managing your investments. After then you'll have enough knowledge/experience to be able to deviate from the forum's advice.

Example of what you will learn. When your funds are losing value (market correction,...), and you begin planning to take advantage of a TLH opportunity, you'll learn it's impossible to hold 2 competing ideas in your mind at the same time. What? You can't be simultaneously thinking about: (1) the best way to maximize your TLH, and (2) worrying that your funds losing value.


If you deviate from the forum's advice before you are ready, able to withstand market fluctuations whipsawing your emotions, it will be a much rougher ride.


For CA residents, in higher tax brackets, it's recommended to use 50/50 shorter-term (ST or limited-term, your choice) national muni/LT CA muni. This gets the paring close to IT duration (on the sweet spot of the risk/reward yield curve), while exempting most of your dividends from both fed and state tax.



(Added) If today you invest in the IT national muni and the LT CA muni, I expect you will have TLH opportunities (steeper price declines) in both, throughout this year (and next ~4yrs). However, if you invest in a shorter-term national muni (instead of VWIUX), you will have less TLH opportunity (price decline and emotional distress).

BH advice. Bond fund interest rate risk (price decline) is based on duration. The longer the duration, the greater will be the interest-rate-change price fluctuation.

BH advice. Bond funds get well based on their duration. If bond funds lose value (price, due to interest rate risk) their price will recover as old issues are replaced by new issues. The get-well date is based on each fund's duration.

Average duration:
--ST national muni: 1yr
--Limited-term national muni: ~2yrs
--IT national muni: 4.4yrs
--LT CA muni: 5.9yrs

Shorter duration fund prices fluctuate less (based on changing interest rates), and get well sooner.

So if you just wait, your bond fund price will recover on its own, with increasing yields each year, with no input from you.

But folks just starting out managing their investments don't know this. And may not be able to tolerate doing nothing for several years, while waiting for the price of longer duration funds to recover*.

* Hence the advice to use shorter durations.

* This is also where TLHing comes in. TLHing allows us the illusion of control, turns lemons (price decline) into lemonade (tax deduction), while distracting us from a fund’s market decline. A multi-year tax deduction is nice, too.



Edit. Typo(s). Second thoughts.

[grabiner]

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

This would cause retirement accounts to likely grow a lot and taxable account to barely grow at all. In retirement, doesn't having a large taxable account become a significant tax advantage? You can get away with paying virtually zero taxes on long term gains, compared to retirements accounts that are typically taxed at ordinary income rates.

In the OP's tax bracket, it won't be as much of an advantage. The OP is in the 32% tax bracket now, and thus isn't likely to retire in a tax bracket in which they pay 0% tax on long-term gains; more likely, it will be 15% federal, and 24.3% total if they retire in CA.

And while it is true that taxable dollars might be worth more than tax-deferred dollars after you retire, tax-deferred dollars will grow faster because you don't pay dividend tax every year. That is the justification for the OPto put stocks in tax-deferred; they lose more portfolio growth by putting stocks in taxable than most investors do, so the higher tax rate on tax-deferred is offset by the larger balance.

For investors in lower tax brackets, particularly in low-tax states, I do normally prefer stocks in taxable and bonds in tax-deferred.

[CFM300]

Gotta love California - beautiful State and man do they charge for it 9.3%! Wow!

And capital gains are taxed as ordinary income, and they don't recognize HSAs.

[cacophony]

And you are probably correct in holding entirely stock in your retirement accounts and munis in taxable, again because of your tax situation. You pay no more tax on CA munis than anyone else, but you pay 28.1% tax on qualified dividends and long-term capital gains on your taxable stock investments, versus a more common 15% difference; this makes CA munis in taxable much more attractive for you than for most investors.

This would cause retirement accounts to likely grow a lot and taxable account to barely grow at all. In retirement, doesn't having a large taxable account become a significant tax advantage? You can get away with paying virtually zero taxes on long term gains, compared to retirements accounts that are typically taxed at ordinary income rates.

In the OP's tax bracket, it won't be as much of an advantage. The OP is in the 32% tax bracket now, and thus isn't likely to retire in a tax bracket in which they pay 0% tax on long-term gains; more likely, it will be 15% federal, and 24.3% total if they retire in CA.

I'm not sure I follow how that works. If the taxable account were to grow to say $5MM then it would be putting off $100k/year in dividends (assuming 2%), which is probably enough for most people to live on. If the OP is married then the federal taxes are zero and the CA taxes are only $3k. That sounds like a pretty ideal situation for somebody retiring early at 50.

[yej84]

Thanks, everyone, for your guidance!

I've decided that, even if it's perhaps not the most tax-efficient solution in terms of asset location, I'd still like to have a muni allocation in my taxable account. That said, I really want to opt for simplicity and use a single muni fund (instead of combining a national muni & California muni), especially since munis will only be ~20% of my taxable account.

So the final question I've been struggling with... do I go with Vanguard CA Intermediate-Term Tax-Exempt (VCADX) for the CA tax break (9.3% state tax), or do I go with Vanguard Intermediate-Term Tax-Exempt (VWIUX) for the national diversification? I've been going back and forth... I'm really the indecisive type!

Also, in terms of when to make the switch, I'll currently be able to harvest about $7,000 in loses by selling Total Bond Market. Should I proceed with selling it now, or wait a while in hopes of even greater losses?

[dratkinson]

...
I've decided that, even if it's perhaps not the most tax-efficient solution in terms of asset location, I'd still like to have a muni allocation in my taxable account. That said, I really want to opt for simplicity and use a single muni fund (instead of combining a national muni & California muni), especially since munis will only be ~20% of my taxable account.

So the final question I've been struggling with... do I go with Vanguard CA Intermediate-Term Tax-Exempt (VCADX) for the CA tax break (9.3% state tax), or do I go with Vanguard Intermediate-Term Tax-Exempt (VWIUX) for the national diversification?

I've been going back and forth (I'm really the indecisive type!). Appreciate any final thoughts/recommendations... thanks!

My 3¢ (inflation).

[begin]

If you can accept...
--"not the most tax efficient" solution,
--"really want simplicity" of single fund,
--and throw in "risk avoidance", if it applies, then your answer would seem to be VWIUX.


On the other hand, if you can accept* more risk, then VCADX would seem to be your answer.

* Meaning you accept the consequence of losing a major portion of your investment to widespread CA financial events, like major earthquake (the big one), fires, insolvency (death spiral state), leading to inability to repay debt/bankruptcy (more widespread than 1994 Orange county),.... Or not. That's why it's called "risk".



Bottom line. You want your investments to run on autopilot, do their thing, and take care of you. You don't want to be worrying about them.

So if you are uncertain as to which solution to choose, then VWIUX is your better solution. Why? It's the one most likely to allow you to pass the SWAN test. (Expected outcome: pass the SWAN test, but regret as it does not give you the most after-tax income.)

You would only choose VCADX, if
--you did not worry about the risk of living/investing in CA.
--Or did worry, but VCADX represents an inconsequential portion of your total investments.

[end]

[yej84]

Thanks, dratkinson, for the very helpful reply! Definitely makes me think I should just go for the greater safety/diversification of VWIUX.

One other question: Should I make the switch now (I'll be able to harvest about $7,000 in losses by selling Total Bond Market). Or are the Bogleheads expecting bond prices to decline even more in the coming months and I should wait in hopes of harvesting even more losses?

[dratkinson]

...
One other question: Should I make the switch now (I'll be able to harvest about $7,000 in losses by selling Total Bond Market). Or are the Bogleheads expecting bond prices to decline even more in the coming months and I should wait in hopes of harvesting even more losses?

Nobody knows nothing.



Disclosure. I'm sitting on some muni TLH opportunities. Why? I prefer a one-and-done solution (vs TLHing multiple times on the way down).

It took ~2yrs to get us here (covid, I think is when interest rates fell/bond prices rose), so it could be a few years for bond prices to stabilize.

And the recent inflation suggests the fed may raise interest rates, further than the recent past high, to slow inflation.

So my plan is to watch/record/track my total loss in each muni fund, and when it stabilizes and begins to decline, call that the point of maximum TLH, so it is the time to execute (one-and-done, for the year).

I have some banked carryover losses, so don't need to harvest the loss this year (or next), so can wait until this plays out for my one-and-done TLH.



My bonds are munis, and I am not losing to taxes. On the other hand, your TBM is taxable and you're losing to the tax bite, against VWIUX*, every year; so you might want to execute sooner rather than later.


Idea.

Today, you could...
--Sell TBM, to pick up $7K TLH.
--Buy VWIUX, to get more after-tax than TBM.* Hold it while interest rates rise/its price drops (accumulating a future TLH).

Later (1-2yrs?).
--When VWIUX's price reverses/begins to rise (your future TLH begins to decline), then harvest its loss by TLHing to VCADX/VMLUX.
--And after 30days, sell VCADX/VMLUX, for an insignificant loss/profit, to return to VWIUX.


Bottom line.
--You harvest ~$7K loss today (TBM TLH).
--VWIUX should produce more after-tax income than TBM.*

--2yrs (?) from now, TLH VWIUX to add to your carryover loss. (TLH partners: VCADX, VMLUX, VWSUX, VCTXX, VMSXX.)
--31days later, sell your TLH partner, for an insignificant loss/gain, to rebuy VWIUX.
--End up back in VWIUX, having harvested the majority of losses for both TBM & VWIUX, and received VWIUX's greater after-tax income benefit* (only missed 1mo).


Notice. If this works as planned, you should be able to harvest ~all possible losses with only 2x TLHs, and so avoid the hassle of TLHing multiple times on the way down.



* Student exercise. I'm assuming VWIUX's TEY is better than TBM's SEC yield (it generally is in higher tax brackets). So, compute the current VWIUX TEY. And compare it to current TBM SEC yield. And if so, then that is your cue to go ahead and switch bond funds in taxable.



Record keeping.

N.B. Ensure you redirect all TBM distributions (to sweep account, checking, mmkt,...) before you TLH. Why? To tell Vanguard that you don't want the prorated dividends reinvested (there will be some for the month in which you sell TBM). Reinvested (prorated) dividends = replacement shares = wash-sale = record-keeping/tax-reporting issue. (Vanguard will take care of the record-keeping for you, since all of the involved accounts/funds are at Vanguard; so your tax-reporting is simple, just report the 1099Bs as-received.)

If you forget this step (to redirect distribution), it's an easy problem to fix, just sell any inadvertent replacement shares and the wash-sale record-keeping stuff will be unwound/net to zero (on Vanguard's 1099Bs). (This knowledge from livesoft's most excellent "real-life real-time wash-sale & TLH" topic: viewtopic.php?t=179414 )


Rhetorical question. But why need to learn to fix a problem (and verify that it's correctly fixed by tracking the record-keeping perturbations through Vanguards' 1099Bs), when you can easily avoid it (and have the record-keeping exactly match what you expected)?

N.B. By learning to avoid the problem, you'll be able to TLH across different providers (Vanguard, Fidelity,...) and have no problems (record-keeping/tax-reporting). Why? Because all across-provider problems belong to you, since no provider will know your total situation. So if you don't want to deal with record-keeping/tax-reporting problems*, then you need to learn to avoid them.

* For an assumed across-provider trade/problem, your records will NOT agree with neither Vanguard nor Fidelity 1099Bs, yet all 3 of you will be reporting to the IRS. The IRS can see your across-provider trades, and so your tax return must adjust** your 1099B reporting to reflex what actually happened when your trade results in the loss of a tax benefit**. (** Assumed wash sale resulting from reinvested distributions. Because you didn't know to redirect distributions before selling. And didn't know to sell the inadvertently purchased replacement shares, so the wash-sale remains.)

** Search: https://www.google.com/search?&q=1099+b ... ment+codes


Bottom line. It's much easier to get into the habit of avoiding problems, than it is to learn how to fix them*.

* On the other hand, you can read livesoft's excellent topic to learn how to fix most** wash-sale problems. (** Hint: Not all wash-sale problems can be fixed. They can only be accepted, in some cases. Or avoided, in all cases. Avoided, is better.)



Edit. Second thoughts. Clarity.

[hudson]

Thanks, everyone, for your guidance!

I've decided that, even if it's perhaps not the most tax-efficient solution in terms of asset location, I'd still like to have a muni allocation in my taxable account. That said, I really want to opt for simplicity and use a single muni fund (instead of combining a national muni & California muni), especially since munis will only be ~20% of my taxable account.

So the final question I've been struggling with... do I go with Vanguard CA Intermediate-Term Tax-Exempt (VCADX) for the CA tax break (9.3% state tax), or do I go with Vanguard Intermediate-Term Tax-Exempt (VWIUX) for the national diversification? I've been going back and forth... I'm really the indecisive type!

Also, in terms of when to make the switch, I'll currently be able to harvest about $7,000 in loses by selling Total Bond Market. Should I proceed with selling it now, or wait a while in hopes of even greater losses?

If I lived in CA, I'd go with VCADX all the way. It's over 90% AAA/AA/A rated.
You get state and federal tax breaks.
Of course, I'd compare the muni deal with safer options like treasuries and CDs.

When to TLH? Usually, I decide well ahead of time what my TLH plan is and what I'm going to do with the money after I sell. Sometimes if you wait, you miss the opportunity. Will I use a TLH partner or will I go somewhere else?

Would your losses be long or short? How attractive would that be on your 2022 tax return?

I'm holding a fixed income ETF with a loss that I could harvest. The ETF is a good fit for me; I like the dividend payout. I can't warm up to the potential TLH partners. I did put a limit order on it to sell if it reaches my buying price. What does one do? I'm going to sleep on it.
Should I harvest? Probably, but I'm going to sleep on it.

Would I wait to see if prices fell even lower? That hasn't worked well for me.