Investing in bond MFs vs Money Market in taxable account

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supersharpie
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Investing in bond MFs vs Money Market in taxable account

Post by supersharpie » Fri Dec 24, 2010 11:37 pm

Why is investing in bond-based mutual funds in taxable accounts a bad idea? Dividends are taxed at 15% vs interest in money market or CDs which is taxed as regular income (in my case 25%). Bond MFs also generally yield several percent more than money market accounts.

Are there any tax issues which I am not considering?

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joe8d
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Post by joe8d » Fri Dec 24, 2010 11:47 pm

Bond fund " dividends" are really interest payouts and are taxed as regular income. It is stock fund dividends that may qualify for QDI treatment and then would have a 15% max under current law.
All the Best, | Joe

supersharpie
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Post by supersharpie » Sat Dec 25, 2010 12:52 am

joe8d wrote:Bond fund " dividends" are really interest payouts and are taxed as regular income. It is stock fund dividends that may qualify for QDI treatment and then would have a 15% max under current law.
Thanks, I knew I was missing part of the equation! That being said, money markets are offering a max of 1.25% interest at this point so, even with the 25% taxation of dividends, it appears that bond-based MFs that offer 5%-9% returns are still far better short-to-mid-term investment options.

phositadc
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Post by phositadc » Sat Dec 25, 2010 9:30 am

Another option--and perhaps the best one for taxable accounts, depending on your marginal tax rate--is tax-exempt bond funds. For short- to medium- term goals where you can tolerate a little more risk than a money market fund would give, check out Vanguard's short-, limited-, and intermediate-term tax exempt bond fund. Returns of 3-6% (hopefully) not subject to federal income tax!

livesoft
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Post by livesoft » Sat Dec 25, 2010 9:44 am

supersharpie wrote:Thanks, I knew I was missing part of the equation! That being said, money markets are offering a max of 1.25% interest at this point so, even with the 25% taxation of dividends, it appears that bond-based MFs that offer 5%-9% returns are still far better short-to-mid-term investment options.
Please list the ticker symbols of the short-to-mid-term bond funds that offer 5%-9% returns. Thanks!

Call_Me_Op
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Post by Call_Me_Op » Sat Dec 25, 2010 9:57 am

livesoft wrote:
supersharpie wrote:Thanks, I knew I was missing part of the equation! That being said, money markets are offering a max of 1.25% interest at this point so, even with the 25% taxation of dividends, it appears that bond-based MFs that offer 5%-9% returns are still far better short-to-mid-term investment options.
Please list the ticker symbols of the short-to-mid-term bond funds that offer 5%-9% returns. Thanks!
Vanguard Intermediate Tax Exempt is yielding a hair under 5% right now (tax equivalent), assuming you are in the highest marginal bracket.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

supersharpie
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Post by supersharpie » Sat Dec 25, 2010 10:01 am

livesoft wrote:
supersharpie wrote:Thanks, I knew I was missing part of the equation! That being said, money markets are offering a max of 1.25% interest at this point so, even with the 25% taxation of dividends, it appears that bond-based MFs that offer 5%-9% returns are still far better short-to-mid-term investment options.
Please list the ticker symbols of the short-to-mid-term bond funds that offer 5%-9% returns. Thanks!
VFSTX
VFIIX
VIPSX
VBIIX
VFITX
VBMFX
VFICX
VWEHX

The first is a short-term bond MF, the other's are intermediate term bond MFs.

livesoft
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Post by livesoft » Sat Dec 25, 2010 10:15 am

I think you had better check your info. I actually own VFSTX, VFIIX, and used to own VIPSX. They may have offered those returns in the past, but what have been their actual "annualized" returns over the last 1-month, 2-months? Thanks!

@Call_Me_Op: highest marginal bracket? LOL!

Valuethinker
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Re: Investing in bond MFs vs Money Market in taxable account

Post by Valuethinker » Sat Dec 25, 2010 10:25 am

supersharpie wrote:Why is investing in bond-based mutual funds in taxable accounts a bad idea? Dividends are taxed at 15% vs interest in money market or CDs which is taxed as regular income (in my case 25%). Bond MFs also generally yield several percent more than money market accounts.

Are there any tax issues which I am not considering?
From the performance numbers you are quoting I think you are confusing 'yield' and 'total return'?

Yield there's more than one way of calculating (there's SEC yield). Prospective yield on a bond fund is probably best estimated by taking the last 12 month's income dividends (no capital gains distributions) and dividing by the current unit price.

Yield for a bond is the annual return (the internal rate of return) arising from the current price, the capital gain or loss at redemption (redemption is almost always $100) and the expected coupons to be paid. Called Yield to Maturity.

Total return for a bond fund would include gains or losses on the prices of the bonds bought and sold. So if the fund bought a bond at $90 and sold at $95, that would give rise to a $5 gain for unit holders.

Recently many bond funds have had large capital gains because of falling interest rates. That is unlikely to be repeated.

Your best long run guide to the likely returns from a bond or bond fund is the current Yield to Maturity-- ie capital gains (and losses) will be a wash. One of John Bogle's articles is quite good on that.

Looking at short term US Treasury Yields now, you are likely to get returns of 2-3% pa maximum from those funds. You will have volatility due to changing interest rates, but less so than for longer maturity bonds.

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#Cruncher
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Post by #Cruncher » Sat Dec 25, 2010 10:28 am

livesoft wrote:I think you had better check your info.
He's right. You may be looking at the year-to-date returns which don't indicate current returns. SEC yield is better.

Also, in general: Bond funds have interest rate risk which MMFs don't. That's the reason they have a higher yield. The risk is, that if interest rates go up, the funds will lose value, while a MMF won't. Generally, both the yield and the risk increase with the maturity of the fund's holdings. E.g., a long-term fund pays the highest interest, but also has the highest interest rate risk.

livesoft
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Post by livesoft » Sat Dec 25, 2010 10:55 am

Anyways, I have no problem with putting one's money in a short-term bond fund instead of a money-market fund. I just don't think one can expect to get 5% to 9% returns going forward doing so.

The one-month returns (not annualized, from M* 'growth-of' charts) are
-1.1% VFIIX
-0.4% VFSTX
-1.6% VIPSX

That's not looking like 5% to 9% to me.

Eureka
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Post by Eureka » Sat Dec 25, 2010 6:05 pm

Just to summarize for the OP: Any bond fund yielding 5 to 9 percent in this interest-rate environment carries considerable interest-rate risk (the net asset value of the shares will fall when interest rates rise) or credit risk (some underlying bonds may go into default, causing a decline in NAV).

Take a look at credit-risk-free bond yields at the end of the week. As of Friday, investors were willing to lend the U.S. government money for 10 years at 3.39 percent and for 30 years at 4.47 percent.

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