VWITX or VBIIX in a Vangaurd taxable account

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invhelpme
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VWITX or VBIIX in a Vangaurd taxable account

Post by invhelpme » Sat Aug 14, 2010 10:35 am

Could someone please help understand why everything you read on the web does not look at the total return of these two bond funds? I am in the 25% tax bracket and have no state income taxes. I know how to use the bond equivalent calculators to see if the yield is better for me using the Vangaurd Intermediate Term tax Exempt fund or the Intermediate Index Fund. The total return of VBIIX is currently 11% vrs the return of VWITX is 5.01%. I might add I intend to buy and hold either of these investments for a long time. Using the bond calculator, the yield comes out better for me using VWITX but no one figures in the bond funds price appreciation. That is a huge part of the return. Why doesn't anyone ever talk about this? It seems to me anyone would have been better off with VBIIX since the total return is so much higher than VWITX. What am I missing here? Any help would be GREATLY appreciated. Daren

Chuck T
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Post by Chuck T » Sat Aug 14, 2010 11:06 am

invhelpme

Welcome to the forum. VWITX is VG's Intermediate Term Tax Exempt Fund. It is more appropriate in a taxable account than a tax deferred account. VBIIX on the other hand is VG's Intermediate Term Bond Index. It is better held in a tax deferred account than a taxable account. As for the current performance figures you site keep in mind they are for this year. What have they been for both funds over the last ten years?

Both are fine funds. I hold the admiral class for VBIIX in my tax deferred account and VMLTX (VG Limited Term Tax Exempt) in my taxable account. VMLTX is a shorter duration version of VWITX.

You need to consider the implication of taxes when you compare a tax exempt versus a taxable bond fund. As to why people don't talk about total return as opposed to income, they do on this site. Some invest in bonds purely for income but others are concerned about total return. Vanguard has a very good brochure on their website which talks in great detail about investing for total return. I will see if I can find the link for you.

Here is a link to investing for total return.
https://institutional.vanguard.com/iip/ ... talRet.pdf

Hope this helps.
Last edited by Chuck T on Sat Aug 14, 2010 11:24 am, edited 2 times in total.
Chuck | Past Performance Is Just That - bob | For info on the SC LowCountry & Savannah GA Area Bogleheads contact me at chucktanner46@gmail.com

dbr
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Post by dbr » Sat Aug 14, 2010 11:12 am

Total return is more important than yield. The problem is that future total return cannot be predicted from immediate past total return. The best predictor that applies with some certainty to bonds is that future yield is predicted by current yield.

On average bonds do not appreciate in price. The deal with a bond is to return an amount loaned out and to pay interest in the meantime. Return the amount loaned out is a deal to achieve zero appreciation in value.

Bond prices on the market are sensitive to interest rates. A bond held during a period of declining interest rates will appreciate in price and a bond held during increasing interest rates will decline in price. If you expect on average neither increase nor decrease in interest rates then you expect on average no change in bond price.

Comparing those two funds for recent return is a comparison of the interest rate trends for the bonds in those funds, which are different bonds in different markets. If you think those interest rate trends are going to persist while you hold the bonds, then you can decide between the funds on that basis. Many people do not think interest rates can be forecast productively. Those that do think they have forecasts of future interest rates seem to be convinced rates will rise and bond prices will fall. You would have to do your own research on what the forecasts are that are specific to the bonds in each fund, or someone here will offer a view.

An important factor is that interest rates do not behave the same for all maturities of bonds. Currently we are in a state where short term rates have fallen to near zero, intermediate term rates have fallen significantly, and long term rates may have had little movement. It is entirely possible short term bonds will be strongly affected by near term interest rate changes, but that little or not effect will be seen in longer term bonds and in munis, but, really, it is just a guess.

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 12:42 pm

Thanks Chuck and dbr for your replies. I understand the funds invest in different bonds and what types of accounts they should be in. Here is what I don't understand. If you look at the 10 year averages, I would still be better off with VBIIX in a taxable account after I take out my taxes in the 25% bracket. I would still be money ahead. This is based on the total return of both funds. Any more advice please? Daren

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RJSachs
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Post by RJSachs » Sat Aug 14, 2010 12:57 pm

You are absolutely right that you would have been better off buying VBIIX at the beginning of the year and selling it now than you would have been with VWITX.

Do you expect capital gains to continue to make up such a significant portion of the fund's returns in the future? Over the time horizon you plan to hold? If so, then go for VBIIX.

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 1:04 pm

RJ, I do plan to hold. I'm just looking at the last 10 years. Everyone bases what they can make by just looking at the dividends. You have to take in the bigger picture which includes the share price. Although no one knows if the past will repeat. Thanks for the reply, Daren

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Taylor Larimore
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Using past performance

Post by Taylor Larimore » Sat Aug 14, 2010 1:08 pm

invhelpme wrote:Thanks Chuck and dbr for your replies. I understand the funds invest in different bonds and what types of accounts they should be in. Here is what I don't understand. If you look at the 10 year averages, I would still be better off with VBIIX in a taxable account after I take out my taxes in the 25% bracket. I would still be money ahead. This is based on the total return of both funds. Any more advice please? Daren
Hi Daren:

The biggest determinant of bond fund return is interest rates and the bond fund's maturity. If interest rates go down, similar funds with the longest-maturity will have the highest return. If interest rates go up, shorter maturity funds will have the highest return.

We have had a long period of generally declining interest rates so longer-term bond funds have enjoyed relatively higher returns. When interest rates go back up, the funds that did well in the past will do poorly in the future.

This is why using past returns for bond funds is dangerous and usually misleading.
"Simplicity is the master key to financial success." -- Jack Bogle

dbr
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Post by dbr » Sat Aug 14, 2010 3:02 pm

invhelpme wrote:Thanks Chuck and dbr for your replies. I understand the funds invest in different bonds and what types of accounts they should be in. Here is what I don't understand. If you look at the 10 year averages, I would still be better off with VBIIX in a taxable account after I take out my taxes in the 25% bracket. I would still be money ahead. This is based on the total return of both funds. Any more advice please? Daren
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People are trying to explain that you cannot expect to obtain the same return in the future that the funds delivered in the past. The actual return you get could be more or less than the ten year averages. Since those averages were earned during a time of declining interest rates, the prediction, if there is one to be made, is that returns will be less. Returns could even be negative. I certainly wouldn't try to forecast which fund would have the greater price appreciation in future.

As an aside, you should also note that capital gains in tax exempt funds are not tax exempt, meaning you cannot apply the effective tax formula to the return but only to the interest. There are also some peculiar limitations to tax loss harvesting in muni funds. Also note, if you consider it and it is relevant, that Treasury bonds are state tax exempt but corporates and some varieties of agency bonds generally are not.

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 4:16 pm

Thank you to Taylor and dbr. I'm not sure what to do. I know interest rates will go up soon and bond prices will fall. I wanted to invest a CD I have due into VBIIX or VWITX, but you guys are right. These funds could lose money for the next 10 years if rates rise slowly. How likely it is I don't know. I suppose I could stick with Limited Term to be safer. Any thoughts? Daren

leonard
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Post by leonard » Sat Aug 14, 2010 4:21 pm

how do you know you will not be going in to a higher tax bracket at some point?
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 4:31 pm

I may if tax brackets change. The highest I could ever see myself in is 28% though.

dbr
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Post by dbr » Sat Aug 14, 2010 4:56 pm

If the plan is to invest in an intermediate term bond fund in a taxable account and your marginal tax rate for that income is 25%-28%, I would invest in VWITX.

If since starting this thread you have a different understanding of the risks and returns inherent in investing in bonds, then you will have to think more about what you are getting in your investments.

My personal opinion is that investors holding balanced stock and bond portfolios for the long run are perfectly well off in intermediate bond funds from Vanguard, with minor nuances separating the various funds. If in taxable at 25% bracket and no option to place the bonds in a tax deferred account instead, I would think a quality muni bond fund would be fine.

Naturally, good advice really requires more information about your objectives and your situation. It might be to your advantage to post your whole portfolio here following the advice in the sticky as very few investment decisions stand alone, independent of how the whole portfolio works:

http://www.bogleheads.org/forum/viewtopic.php?t=6212

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 5:06 pm

Thanks dbr. I have to run right now. I greatly appreciate your wisdom and advice. I have a 50/50 mix of stock and taxable bond funds in our IRA's. I just wanted to add this CD money to my taxable account and let it grow for 15 years. Since VBIIX has an overall greater return even after taxes are considered I thought thought I would still be ahead investing in that fund vrs.VWITX. Thanks again everyone, Daren

DSInvestor
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Post by DSInvestor » Sat Aug 14, 2010 5:55 pm

invhelpme wrote:Thanks dbr. I have to run right now. I greatly appreciate your wisdom and advice. I have a 50/50 mix of stock and taxable bond funds in our IRA's. I just wanted to add this CD money to my taxable account and let it grow for 15 years. Since VBIIX has an overall greater return even after taxes are considered I thought thought I would still be ahead investing in that fund vrs.VWITX. Thanks again everyone, Daren
If 50% of your IRA space is used to hold stocks, why not shift some stocks out of the IRA to make room for preferred bond fund VBIIX? This way, you'd hold the higher yielding tax inefficient bond fund in a tax sheltered account and hold tax efficient stocks in the taxable account.

Here are two portfolios of 100K with 40/60 stock/bond AA:

Portfolio 1:
Taxable:
20K Intermediate Term Bond Index VBIIX

IRA:
40K Bonds
40K Stocks

Overall AA 40K stocks, 60K bonds.

Portfolio 2:
Taxable:
20K Stocks

IRA:
40K Bonds
20K Intermediate Term Bond Index VBIIX
20K Stocks

Overall AA 40K stocks, 60K bonds (same as Portfolio 1).

Which portfolio would be more tax efficient?

invhelpme
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Post by invhelpme » Sat Aug 14, 2010 8:51 pm

Thanks DSIinv. for the reply. I really appreciate your help. That helps a lot.

knowmad
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Re: VWITX or VBIIX in a Vangaurd taxable account

Post by knowmad » Sun Aug 15, 2010 12:33 pm

Vanguard says that VBIIX has a 10 year return after taxes of 5.04%, while VWITX returned 4.81%. But VBIIX has ~1 year greater duration and maturity than VWITX, making VBIIX more sensitive to interest rate changes. That seems about fair. An extra .23% annual return for increased risk.

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