munis look relatively cheap

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larryswedroe
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munis look relatively cheap

Post by larryswedroe » Wed Mar 20, 2013 12:26 pm

http://www.cbsnews.com/8301-505123_162-57575334/municipal-bonds-are-looking-better-and-better/

post explains why and also that far too many lower bracket investors automatically assume that munis are not for them. Sometimes that's the case, but not now. And hasn't generally been true for years now, since the crisis began

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Re: munis look relatively cheap

Post by rmelvey » Wed Mar 20, 2013 12:37 pm

"Historically, AAA-rated municipal bonds have traded at a discount to Treasuries. However, the recent financial crisis has changed that, and you may want to give munis another look for your portfolio."

Did you mean to write premium instead of discount? The word discount makes me think of price, but I think you meant to say they normally trade at a lower yield.

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Re: munis look relatively cheap

Post by FillorKill » Wed Mar 20, 2013 12:49 pm

Incorporating high quality munis into the FI allocation may also give an investor more flexibility with how they use their [often limited] tax advantaged space. That’s nothing to sneeze at.

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Re: munis look relatively cheap

Post by linenfort » Wed Mar 20, 2013 1:28 pm

Hmm, this article has me wondering about VPAIX once again.
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Re: munis look relatively cheap

Post by larryswedroe » Wed Mar 20, 2013 3:30 pm

Rmelvey
'An editor changed the wording from my submission, should have said muni yields have traded at a discount historically
Larry

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Wed Mar 20, 2013 3:57 pm

Thank you for this post.

Myself, I love bonds and div. stocks. Being in the highest tax bracket, getting eaten alive by the fed, state taxes, plus the bump in dividend tax rate to 20%, I shifted into Vanguard's municipal bond funds. Really, really hoping they keep their tax-exempt status.

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Re: munis look relatively cheap

Post by NYBoglehead » Wed Mar 20, 2013 4:06 pm

DualIncomeNoDebt wrote:Thank you for this post.

Myself, I love bonds and div. stocks. Being in the highest tax bracket, getting eaten alive by the fed, state taxes, plus the bump in dividend tax rate to 20%, I shifted into Vanguard's municipal bond funds. Really, really hoping they keep their tax-exempt status.


If you are in the bracket that now pays 20% for dividends you also paying the 3.8% ACA surtax on investment income. 23.8% total on dividends in a taxable account, might make munis even more attractive.

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Re: munis look relatively cheap

Post by Occupier » Wed Mar 20, 2013 7:17 pm

Yup. The last General Obligation muni bond default was Arkansas in the dust bowl era. Treasuries have come close to default a couple of times recently due to intransigence in Congress. At least states and municipalities know they have to have money coming in to pay you. That is more than I can say for Treasuries. Dave

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Re: munis look relatively cheap

Post by Gleevec » Wed Mar 20, 2013 7:39 pm

Munis are amazing right now, not only because of the multiple tax breaks you get, but also because (as Larry states in his article) they are ironically less dependent on government (Fed) intervention) so will actually respond to market forces.

I really doubt the muni tax benefit will be taken away, local economies are hurting badly and if the federal government were to institute a muni tax, there would probably be a massive shift of income to other asset classes. Especially when you consider that if muni's are used as a tax shelter by the wealthy, it is likely the outflows will involve large sums of money per investor potentially-- esp in CA and NY

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Re: munis look relatively cheap

Post by SGM » Wed Mar 20, 2013 7:46 pm

I have almost all my bonds in munis.When Whitney's statements came out, it was an opportunity to buy muni bond funds at a nice discount esp. NY and CA. Palpable fear is great for the calm who follow a plan. :D
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Re: munis look relatively cheap

Post by larryswedroe » Wed Mar 20, 2013 8:31 pm

Occupier
Note that default doesn't necessarily mean LOSS, just not timely payment of interest and principal!!!
Larry

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Re: munis look relatively cheap

Post by fx24 » Wed Mar 20, 2013 9:30 pm

I post this same thing 4 days ago and got no support. Tough crowd. :?

viewtopic.php?f=1&t=113107&newpost=1645909

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Re: munis look relatively cheap

Post by larryswedroe » Wed Mar 20, 2013 9:33 pm

fx24
FWIW we won't touch health care related bonds regardless of the rating, only GOs and essential service (like water/sewer)revenue bonds.All one needs is changes in how hospitals get paid (like reduced payments from Medicare/Medicaid) and down goes the credit quality.

That is why that bond is yielding so high--it's way over the yield of the quality we buy, and for good reason
Forewarned is forearmed
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Re: munis look relatively cheap

Post by Leesbro63 » Wed Mar 20, 2013 9:46 pm

DualIncomeNoDebt wrote:
NYBoglehead wrote:If you are in the bracket that now pays 20% for dividends you also paying the 3.8% ACA surtax on investment income. 23.8% total on dividends in a taxable account, might make munis even more attractive.


Yes. Mid-six to very low seven-figure income per year. Getting it from all sides, it's why we shifted to muni funds this year. [political comment removed]


Why the wake up just now? Munis have been the fixed income "go to" choice for high income investors for generations.

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Thu Mar 21, 2013 12:02 am

Leesbro63 wrote:Why the wake up just now? Munis have been the fixed income "go to" choice for high income investors for generations.


In the past, generally had favored dividend-paying stocks and the 15% rate. This forum, together with the recent tax law changes at both federal and state level, have resulted in a major shift in thinking.

Another question. Assume investor owns Wellesley Admiral in taxable. Investor also is in highest fed and state tax bracket, and paying the 20% div tax plus the 3.8% ACA tax. In this case, does it make sense to move the taxable account allocation from Wellesley to Vanguard's intermediate and perhaps long-term muni funds? No need to touch the funds, even in rising interest rate environment. What if the move results in a large allocation to muni bond funds in taxable, on the order of 60%+ of allocation. Is this move advisable due to tax efficiency?

Also, do high income earners maintain 100% allocations to municipal bonds or bond funds in their taxable accounts? Ross Perot comes to mind . . . .

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Re: munis look relatively cheap

Post by BrandonBogle » Thu Mar 21, 2013 12:06 am

^^ wouldn't this mean you cut back on your stocks since Wellesley holds some large caps as well? Or are you saying your buy the appropriate amounts of TSM and TISM to make up for that?

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Thu Mar 21, 2013 12:10 am

BrandonBogle wrote:^^ wouldn't this mean you cut back on your stocks since Wellesley holds some large caps as well? Or are you saying your buy the appropriate TSM and TISM to make up for that?


That's exactly what it would mean. Lower stock allocation, period. Nowhere to go in tax-advantaged. Don't qualify for Roth, 401K maxed, and a pension fund which has an outside investment advisor who has us in iShares three-fund portfolio equivalents.

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BrandonBogle
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Re: munis look relatively cheap

Post by BrandonBogle » Thu Mar 21, 2013 12:16 am

DualIncomeNoDebt wrote:
BrandonBogle wrote:^^ wouldn't this mean you cut back on your stocks since Wellesley holds some large caps as well? Or are you saying your buy the appropriate TSM and TISM to make up for that?


That's exactly what it would mean. Lower stock allocation, period. Nowhere to go in tax-advantaged. Don't qualify for Roth, 401K maxed, and a pension fund which has an outside investment advisor who has us in iShares three-fund portfolio equivalents.


Personally, I wouldn't lower my equity allocation in the process. But putting that aside for the moment (and any potential cap gains on selling Wellesley), the yes, a muni bond fund that won't by touched for at least it's duration could be appriopriate.

Again, I'd personally think hard about how you'd set your overall AA and then pick what to use for the three-fund components, using a municipal bond fund for the bond component in taxable.

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Re: munis look relatively cheap

Post by BrandonBogle » Thu Mar 21, 2013 12:20 am

DualIncomeNoDebt wrote:Another question. Assume investor owns Wellesley Admiral in taxable. Investor also is in highest fed and state tax bracket, and paying the 20% div tax plus the 3.8% ACA tax.


I should mention that I'm personally in the 25% bracket (almost, was in 15%), so there could very likely be influences I'm not aware of/considering.

I do wish I had your problem though!! :)

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Thu Mar 21, 2013 12:20 am

Thank you. The 2013 tax changes, plus the recent California tax changes, have complicated the analysis. Had a comfortable AA of 60% bonds 40% stocks. But these recent tax changes have me rethinking everything concerning the taxable accounts. Counting the days till we vacate CA. Will be happy to visit and provide a landlord some rental income in the summer, perhaps.

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Thu Mar 21, 2013 12:24 am

BrandonBogle wrote:I do wish I had your problem though!! :)


The stress of thinking about and providing for our employees, in this environment, it's given me quite a few sleepless nights. Knowing they have families and young kids and they are relying on us to make the right decisions. Ugh, I can't tell you how much I hate the pressure, because we care. These are problems no one wants, scout's honor.

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Re: munis look relatively cheap

Post by BrandonBogle » Thu Mar 21, 2013 12:27 am

DualIncomeNoDebt wrote:
BrandonBogle wrote:I do wish I had your problem though!! :)


The stress of thinking about and providing for our employees, in this environment, it's given me quite a few sleepless nights. Knowing they have families and young kids and they are relying on us to make the right decisions. Ugh, I can't tell you how much I hate the pressure. These are problems no one wants, scout's honor.


That I can understand. Replace one worry with another. I'm currents visiting my mom in Florida to sell my VW Eos convertible so I have an seperate emergency fund for any expected health bills she might come up against. I guess it's true that regardless of where you are in the spectrum, there will always be someone depending on you and you worry about their well being.

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Re: munis look relatively cheap

Post by SnowSkier » Thu Mar 21, 2013 10:11 am

Larry, All,

For someone using bond funds instead of individual bonds, any comments or suggestions regarding VWLUX vs. VWIUX vs. VMLUX vs. VWSUX?

Code: Select all

VWLUX, VG Long-Term Tax-Exempt,         duration 6.3y, SEC yld 2.23%, 59% AA+
VWIUX, VG Intermediate-Term Tax-Exempt, duration 5.1y, SEC yld 1.62%, 68% AA+
VMLUX, VG Limited-Term Tax-Exempt,      duration 2.3y, SEC yld 0.60%, 76% AA+
VWSUX, VG Short-Term Tax-Exempt,        duration 1.1y, SEC yld 0.36%, 80% AA+


I'd greatly appreciate any high-level education on muni bonds. I'm a newbie on bonds other than historically just using TBM, so have much to learn. So far some of the few overall-bond words of wisdom I have learned, off the top of my head, are, paraphrasing,
    "keep terms short and quality high",
    "short-term investment-grade / corp has rewarded the credit risk more than int-term inv grade or HY or ...", and
    "take your risk on the equity side".
Could easily be mis-stating some of this.
I'm not sure how to think about munis in terms of duration, yield, etc, so just seeking to get a little smarter here, and wanted to let folks know this is a newbie question in case I'm unintentionally asking some dumb questions. :happy

Thanks

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Re: munis look relatively cheap

Post by EDN » Thu Mar 21, 2013 10:53 am

I am going to disagree here that munis are "cheap" or represent some obvious opportunity for everyone, especially those who pay little to no taxes. The fact is, if we use Vanguard muni funds as our bogey for the short and intermediate tax-free asset class, then absolutely no one should own any munis in the short-term space (5 years or less) regardless of tax bracket, and if you want to stretch for yield and buy intermediate, then you probably should be north of the 28% tax bracket at least. This is based on a comparison of Vanguard Limited Term Tax Exempt and Short Term Investment Grade funds, as well as Intermediate Term Tax Exempt and Intermediate Investment Grade.

I would not compare munis of any credit quality (and thats assuming you believe the credit rating) to US treasury bonds. The former have tax risk, liquidity risk, geographical risk, among other things. The later are the only investment asset class there is that "decouples" from everything else in periods of financial crises. As we know investors are risk averse, that feature fetches a very large premium in the expected return department.

Now, if you don't covet this decoupling aspect of treasuries, that's fine, consider munis and corporate bonds. But you cannot compare a risk asset to a risk free asset and assume one is cheap relative to the other. All you can say is the "price of safety" seems to be high/low.

You are always better off starting from the perspective that markets work and prices are approximately right, and therefore differences in price and expected return are a function of risk.

Eric

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Re: munis look relatively cheap

Post by learning_head » Thu Mar 21, 2013 10:54 am

CDs offer comparable yields even after 50% tax (~0.83% on penfed 5yr cd vs ~0.91% 5-yr muni bonds in the article) and have guaranteed premium (i.e. no chance of loss due to interest rates going up). So, why bother with the muni's?

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Re: munis look relatively cheap

Post by STC » Thu Mar 21, 2013 10:54 am

Larry - for those of us who are too lazy to pick individual Muni bonds, would SHM (iShares Short term national Muni) be a good alternative?

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Re: munis look relatively cheap

Post by larryswedroe » Thu Mar 21, 2013 10:58 am

Eric
First, your point about taxable vs munis is correct-it's always about the math, which is why owning a muni fund may not make sense because it owns munis when taxables for some part of the curve are better. As I have noted many times here, we have been buying CDs often for taxables even at the higher brackets, for the shorter end of the curve.
Second, Yes those issues you raise are correct, which is why munis have historically traded at say 80% of Treasuries and not say 65% (assuming 35% bracket) --the extra return is compensation for those risks. The point of the article was to note that munis are RELATIVELY cheap now compared to Treasuries in terms of historical spreads.

Learning head. That point about no chance of loss if rates rise is just your illusion. Sure there is a loss, it's just your failure to mark it to market.


Larry

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Re: munis look relatively cheap

Post by cks » Thu Mar 21, 2013 1:39 pm

I like to think that we can look at the current muni market in one of two ways: Either the market is correct and they have priced the risks EDN listed above + credit risk into the equation or the market is wrong and the Munis really are "cheap". Either way you probably have a 50/50 chance of being right.

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Re: munis look relatively cheap

Post by EDN » Thu Mar 21, 2013 1:47 pm

cks wrote:I like to think that we can look at the current muni market in one of two ways: Either the market is correct and they have priced the risks EDN listed above + credit risk into the equation or the market is wrong and the Munis really are "cheap". Either way you probably have a 50/50 chance of being right.


Actually, I'd say the first option (the market is correct) is going to be right 99% of the time, the second (the market is wrong) will be right 1% of the time. Look no further than the results from the active management community, if markets really were persistently wrong in a way we could exploit, we'd see alpha beyond what we'd expect simply by chance. But we don't. This is a universal trait in investing, you can apply it to almost any situation.

Eric

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Re: munis look relatively cheap

Post by cks » Thu Mar 21, 2013 2:16 pm

EDN wrote:
cks wrote:I like to think that we can look at the current muni market in one of two ways: Either the market is correct and they have priced the risks EDN listed above + credit risk into the equation or the market is wrong and the Munis really are "cheap". Either way you probably have a 50/50 chance of being right.


Actually, I'd say the first option (the market is correct) is going to be right 99% of the time, the second (the market is wrong) will be right 1% of the time. Look no further than the results from the active management community, if markets really were persistently wrong in a way we could exploit, we'd see alpha beyond what we'd expect simply by chance. But we don't. This is a universal trait in investing, you can apply it to almost any situation.

Eric


I think it depends on your definition of what the "market" is. Over the past two decades, in cases of dot-com and housing bubbles, many in the "market" were wrong, but then again many (although probably fewer in number than the former group) were right (e.g. John Paulson). Either way you look at it, I find the "boglehead way" very appealing.

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Re: munis look relatively cheap

Post by rkhusky » Thu Mar 21, 2013 2:28 pm

cks wrote:
EDN wrote:
Actually, I'd say the first option (the market is correct) is going to be right 99% of the time, the second (the market is wrong) will be right 1% of the time. Look no further than the results from the active management community, if markets really were persistently wrong in a way we could exploit, we'd see alpha beyond what we'd expect simply by chance. But we don't. This is a universal trait in investing, you can apply it to almost any situation.

Eric


I think it depends on your definition of what the "market" is. Over the past two decades, in cases of dot-com and housing bubbles, many in the "market" were wrong, but then again many (although probably fewer in number than the former group) were right (e.g. John Paulson). Either way you look at it, I find the "boglehead way" very appealing.


What is the right price? Is something priced wrong today if the price drops in the future?

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Re: munis look relatively cheap

Post by EDN » Thu Mar 21, 2013 2:45 pm

cks wrote:
EDN wrote:
cks wrote:I like to think that we can look at the current muni market in one of two ways: Either the market is correct and they have priced the risks EDN listed above + credit risk into the equation or the market is wrong and the Munis really are "cheap". Either way you probably have a 50/50 chance of being right.


Actually, I'd say the first option (the market is correct) is going to be right 99% of the time, the second (the market is wrong) will be right 1% of the time. Look no further than the results from the active management community, if markets really were persistently wrong in a way we could exploit, we'd see alpha beyond what we'd expect simply by chance. But we don't. This is a universal trait in investing, you can apply it to almost any situation.

Eric


I think it depends on your definition of what the "market" is. Over the past two decades, in cases of dot-com and housing bubbles, many in the "market" were wrong, but then again many (although probably fewer in number than the former group) were right (e.g. John Paulson). Either way you look at it, I find the "boglehead way" very appealing.


Yes, those are common examples used by some to illustrate massive pricing errors, but I don't thing they work so well.

To "justify" valuations in tech stocks, we would have needed only produce 1-2 other companies as profitable at the time as MSFT. People forget how universal a belief it was that the internet was going to revolutionize business. What are deserving valuations for companies with such potential? The other thing, of course, is where are all the millionaires and billionaires who correctly profited from the bubble? Sure, in a market of millions of investors, you can find a few, just like lottery ticket winners. But it doesn't say much about market prices being wrong to the point of exploitation. There were cries of irrational exuberance 4 years before stock prices eventually fell. I hear more stories about the barber from Cape Cod who lost everything on EMC (and then EK in 2008).

Same thing goes for the real estate bubble. Yes prices were volatile, yes stocks fell a lot. But what would you expect to happen with so much uncertainty around government policy? This company gets a lifeline, that one doesn't? Trillion dollar "stimulus" plans? Prices have to react violently to those realities. If there was any "errors" involved, it had more to do with artificially low interest rates and widespread housing incentives that distorted markets--not markets themselves failing. But again, outside of a few hedgies (like Paulson) who have since imploded, who profited from this? Peter Schiff was quite prescient in his warnings that excessive bank credit expansion and central bank policies would lead to a major economic dislocation (but anyone who understood Austrian BCT 101 could have told you that), yet he lost more in 2008 that most everyone else. And his calls ever since haven't been nearly as accurate.

Remember, market efficiency doesn't say that prices are always right, or that they never go down (or down a lot), just that they reflect all available (public) information and cannot be consistently exploited by a majority of investors. That seems pretty accurate to me.

Eric

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Re: munis look relatively cheap

Post by larryswedroe » Thu Mar 21, 2013 2:51 pm

eric
Actually if memory serves Jeremy Siegel wrote a piece that showed no logical assumption about future earnings growth could have justified the valuations because the companies would have become larger than the economy
Larry

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Re: munis look relatively cheap

Post by cks » Thu Mar 21, 2013 3:14 pm

rkhusky wrote:
cks wrote:
EDN wrote:
Actually, I'd say the first option (the market is correct) is going to be right 99% of the time, the second (the market is wrong) will be right 1% of the time. Look no further than the results from the active management community, if markets really were persistently wrong in a way we could exploit, we'd see alpha beyond what we'd expect simply by chance. But we don't. This is a universal trait in investing, you can apply it to almost any situation.

Eric


I think it depends on your definition of what the "market" is. Over the past two decades, in cases of dot-com and housing bubbles, many in the "market" were wrong, but then again many (although probably fewer in number than the former group) were right (e.g. John Paulson). Either way you look at it, I find the "boglehead way" very appealing.


What is the right price? Is something priced wrong today if the price drops in the future?


Good point. It obviously depends on whether you were long or short on the commodity. Larry's referenced article is in fact asking you to consider going "long" on the muni market because it may be underpriced. Maybe the article's right, maybe it's wrong. Who knows? It's good reading and stimulates thought and discussion which is great.

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Re: munis look relatively cheap

Post by EDN » Thu Mar 21, 2013 3:49 pm

larryswedroe wrote:eric
Actually if memory serves Jeremy Siegel wrote a piece that showed no logical assumption about future earnings growth could have justified the valuations because the companies would have become larger than the economy
Larry


Larry,

Here's a snipet from an interview with Fama on the subject:

IRRATIONAL EXURBERANCE

Region: Some economists—you know them well—say that the stock market crash of 1929 and the more recent climb and decline of the market in the early 2000s suggest that “irrational exuberance” affects the stock market. How do you reconcile this alleged evidence of herding behavior and animal spirits with the notion of market efficiency?

Fama: Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient.
The word “bubble” drives me nuts. For example, people say “the Internet bubble.” Well, if you go back to that time, most people were saying the Internet was going to revolutionize business, so companies that had a leg up on the Internet were going to become very successful.
I did a calculation. Microsoft was an example of a corporation that came from the previous revolution, the computer revolution. It was hugely profitable and successful. How many Microsofts would it have taken to justify the whole set of Internet valuations? I think I estimated it to be something like 1.4.

Region: About one and a half Bill Gateses.

Fama: That’s right. And Microsoft was a good example because the worse their products were, the more money they made [laughter]. Who didn’t struggle with DOS and then the first versions of Windows?

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Re: munis look relatively cheap

Post by DualIncomeNoDebt » Thu Mar 21, 2013 3:59 pm

Reupping a previous question I had. Is it appropriate for a high income earner, maxed in all tax brackets, and without any tax-advantaged space, to maintain a 90% or even 100% allocation to municipal bonds or bond funds in their taxable account?

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Re: munis look relatively cheap

Post by learning_head » Thu Mar 21, 2013 4:02 pm

larryswedroe wrote:Learning head. That point about no chance of loss if rates rise is just your illusion. Sure there is a loss, it's just your failure to mark it to market.


It's not an illusion because you are not looking at the terms of the two investments. In other words, you are not marking CDs to market correctly I think...

If interest rates rise, I can close my CD (with some penalty on interest) and I will my principal back, plus maybe some interest. (Then I can reinvest in higher-rated CDs.) If I invested in munibond fund, however, I may not be able to get my principal back. (And if I invested in individual muni-bonds, which I assume most people can't / shouldn't, then I don't think many would let you call them early for reinvestment.)

So, I come back to... why bother with muni's when CDs are about the same even in 50% bracket...

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Re: munis look relatively cheap

Post by larryswedroe » Thu Mar 21, 2013 4:16 pm

Eric
I remember that piece well but also remember the Siegel piece too, at least I think so, I haven't had time to try and dig it up

Dualincomeno debt
Yes holding munis in taxable is fine, at these levels one could argue that's it's more tax efficient to do so.
Larry

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