Allan Roth Says Not to Load Up on Muni Bonds

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Allan Roth Says Not to Load Up on Muni Bonds

Post by Leesbro63 »

I generally find Mr. Roth to be very "mainstream", but this seems to be "offbeat": http://blog.aarp.org/2015/07/14/4-reaso ... uni-bonds/
Last edited by Leesbro63 on Mon Aug 03, 2015 4:19 pm, edited 1 time in total.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Rick Ferri »

Yes, but he also recommended muni bond funds:

" Buying a low-cost muni bond fund through firms like iShares or Vanguard will avoid both the income illusion and the illiquidity issues mentioned earlier."

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Re: Allan Roth Says to Avoid Muni Bonds

Post by Leesbro63 »

I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Last edited by Leesbro63 on Mon Aug 03, 2015 9:56 am, edited 1 time in total.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by BigJohn »

The reasons in this article are why I stopped investing in individual muni bonds years ago and started using VG Int Term Muni Bond fund.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Allan Roth »

I think you should re-read the article as I never said "avoid muni bonds." In fact I stated:

1) I own muni bonds (via a Vanguard fund)
2) It may be okay to weight up to twice the market cap on munis.

All I'm pointing out is that munis are not risk-free and many investors aren't aware of some of the downsides.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by lack_ey »

And that the upside, on an after-tax basis, should be considered. No point in paying less taxes if it means lower after-tax risk-adjusted returns.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Allan Roth »

lack_ey wrote:And that the upside, on an after-tax basis, should be considered. No point in paying less taxes if it means lower after-tax risk-adjusted returns.
I couldn't agree more - some people seem to have the goal of paying less in taxes and I have an easy solution - quit your job, give all of your money away, and live under a bridge. Making more after taxes is the better goal but one must take into account the risks associated with making more on an investment.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Leesbro63 »

I stand somewhat corrected on my original post. I still think it appropriate to be here and will leave it, but perhaps I was too negative on my initial interpretation of the message. Sorry about that Allan!
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Re: Allan Roth Says to Avoid Muni Bonds

Post by SGM »

I am happy to see that Allan Roth is okay with low cost muni bond funds. I had the impression from a conversation at BH 13 that he was only in favor of treasuries.

I have seen the falsely high return of individual muni bonds in a relative's portfolio. It is much as described in the piece above. Unfortunately, it is futile to try to change the relative's portfolio.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by VictoriaF »

What is the current sweet spot for municipal bond funds? I have some maturing CDs and need to find a place to invest the proceeds. Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (VWITX) now yields 1.83% which is equivalent to 2.5% in CD income in the 28% bracket. Are there any reasons not to invest in it?

Allan's last point in the referenced article is
Allan Roth wrote:4. Munis may now be tied to the stock market. Over the long run, if stocks do poorly, there could be systemic defaults on munis.
This risk applies to muni funds (such as VWITX) as well as to individual munis. Right?

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Re: Allan Roth Says to Avoid Muni Bonds

Post by cfs »

Thank you.

Thanks shipmate LB for the link. Now, here is Allan Roth's advise--"Muni bonds represent about 10 percent of the U.S. investment-grade bond market and I recommend not having more than twice that percentage in anyone’s portfolio." Guilty as charge, I have a large percentage in muni bond funds.

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Re: Allan Roth Says to Avoid Muni Bonds

Post by Allan Roth »

Leesbro63 wrote:I stand somewhat corrected on my original post. I still think it appropriate to be here and will leave it, but perhaps I was too negative on my initial interpretation of the message. Sorry about that Allan!
No problem at all. I probably should have been more tactful in clarifying. Thanks.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by goingup »

From the article: "Muni bonds represent about 10 percent of the U.S. investment-grade bond market and I recommend not having more than twice that percentage in anyone’s portfolio."

That's a bit of a wake up call for me. We probably have close to 50% fixed income in intermediate and limited term muni funds. With 2/3 of the portfolio in a taxable account it seemed like a good solution.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by matjen »

Just a reminder that not all muni bond funds are the same. I'm not sure whether this would change Mr. Roth's rule of thumb but since I knew I would have a large slug of muni funds I decided to go with about the safest and most conservative one I could find and that is Baird Intermediate Muni Bond Inst (BMBIX).

It is much higher quality than most other muni bond funds...including Vanguard's.

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Re: Allan Roth Says to Avoid Muni Bonds

Post by theunknowntech »

Leesbro63 wrote:I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Hmmm. I own a bunch of individual munis from a long time ago, and they are paying between 5 and 6 percent in my pocket, tax free, every year, verified (I do my own taxes.) Try THAT with a current-issue CD.

The suggestion is that I should get rid of them? I doubt that. Interestingly, when they ARE put up for sale, the buyers are few.

One of my blind spots is that I'm not quite sure of the reason for the illiquidity of an asset like that.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by rkhusky »

When comparing muni vs. corporate bonds, keep in mind that in the past the ratings for munis have tended to be more conservative then corporates in terms of default rate, i.e. AA rated corporates have had historically a much higher default rate than AA-rated munis.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Artsdoctor »

I think that's a fair assessment on all accounts, but I do think that there are some factors which can help protect the investor.

1. If you buy an individual muni at auction, you're avoiding a mark-up.
2. In order to avoid selling a relatively illiquid investment at exorbitant fees, you should anticipate holding the individual bond until maturity if that fits with your investment plan.
3. It is true that municipalities are under tremendous strain to meet pension obligations and that if there is another financial meltdown with severe losses, the risk of defaults increase; however, states cannot declare bankruptcy so it's unclear how a state can default on it's GO bonds.
4. If you're really concerned about credit risk, you can buy pre-refunded munis, again with the goal of holding until maturity, and taking on no more credit risk than treasuries.
5. You should never just look at the coupon, you need to look at the yield to maturity (or yield to worst if it's a callable bond). You'll need to amortize the premium bond appropriately (and if it's out-of-state, that amortization can off-set the coupon).
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Allan Roth »

theunknowntech wrote:
Leesbro63 wrote:I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Hmmm. I own a bunch of individual munis from a long time ago, and they are paying between 5 and 6 percent in my pocket, tax free, every year, verified (I do my own taxes.) Try THAT with a current-issue CD.

The suggestion is that I should get rid of them? I doubt that. Interestingly, when they ARE put up for sale, the buyers are few.

One of my blind spots is that I'm not quite sure of the reason for the illiquidity of an asset like that.

I don't know your situation so I haven't suggested you get rid of them. They are very expensive to sell.

I'd bet heavily that you are not earning 5-6%. Your principal value is declining. Your tax return may show this as you may have bought them years ago and they appreciated due to declining rates as nearly all bonds and bond funds did. The illiquidity comes form the huge number of tiny bonds floated and the fact that there is no national exchange for bonds as there is for stocks. I suspect the latter is due to the fact that the industry makes so much money on the spreads and they don't want a national exchange.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Artsdoctor »

It's POSSIBLE that he's truly earning 5% although he'd have to clarify how that is occurring. If he bought a premium bond with a 5% coupon which matures in 2020 and had a call date of 2013, he no longer is amortizes the bond premium (of course, one would be surprised if the bond wasn't called). And there were definitely 30-year munis with 5% coupons years ago; if they were discounted, he'd be making 5% without amortizing. But again, most of those bonds would've been called by now.

But I agree: the 5% coupon is probably a premium bond and he's not amortizing it on his tax return, presumably because it's in his own state.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by theunknowntech »

Allan Roth wrote:
theunknowntech wrote:
Leesbro63 wrote:I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Hmmm. I own a bunch of individual munis from a long time ago, and they are paying between 5 and 6 percent in my pocket, tax free, every year, verified (I do my own taxes.) Try THAT with a current-issue CD.

The suggestion is that I should get rid of them? I doubt that. Interestingly, when they ARE put up for sale, the buyers are few.

One of my blind spots is that I'm not quite sure of the reason for the illiquidity of an asset like that.

I don't know your situation so I haven't suggested you get rid of them. They are very expensive to sell.

I'd bet heavily that you are not earning 5-6%. Your principal value is declining. Your tax return may show this as you may have bought them years ago and they appreciated due to declining rates as nearly all bonds and bond funds did. The illiquidity comes form the huge number of tiny bonds floated and the fact that there is no national exchange for bonds as there is for stocks. I suspect the latter is due to the fact that the industry makes so much money on the spreads and they don't want a national exchange.
But I AM earning 5-6% interest every year on these munis. If you bet against that, you'd be entering into a suckers bet, and that's beneath my dignity. Best regards and respect.

Why would these things be so difficult to sell. Possibly because people are incredulous, dunno.

If you understood what a municipal bond really is on a fundamental level, down to the signature, and really FELT what was going on behind it, you might change your tune.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Artsdoctor »

^ I don't think anyone here would be doubting that you're getting a 5% coupon.

One of the issues that many people have, and I'm not saying that would be you, is that your coupon does not usually reflect your yield. I can easily buy an individual bond on the market right now that has a coupon of 5%, but it would be a premium bond (for example, I'd pay $30,000 to buy 25 bonds that would pay me $25,000 on the date of maturity). Many people see that $1,250 of income each year and think they're getting 5%, but they're not taking the amortization into account.

Virtually no one buys a bond at exactly par, even at auction.

Munis are not just illiquid, but the prices are not transparent. It's easier than it used to be, but one could easily give up an entire year of yield by selling at unfair (and typical) price. Take a look at the ask/bid spread and you'll see what I'm talking about.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Allan Roth »

theunknowntech wrote:
But I AM earning 5-6% interest every year on these munis. If you bet against that, you'd be entering into a suckers bet, and that's beneath my dignity. Best regards and respect.

Why would these things be so difficult to sell. Possibly because people are incredulous, dunno.

If you understood what a municipal bond really is on a fundamental level, down to the signature, and really FELT what was going on behind it, you might change your tune.
You may want to consider a couple of biases that could be going on - both overconfidence and confirmation bias. VWIUX currently yields 1.92% but you can earn 3x that amount. The logical conclusion is that you are 3x the muni bond manager that Vanguard is. I'm sorry but I respectfully question that claim and merely suggest you do so as well. Again, much of your perceived income comes from the fact that rates declined and principal values increased - at least that is what I suspect.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Leesbro63 »

theunknowntech wrote:
Leesbro63 wrote:I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Hmmm. I own a bunch of individual munis from a long time ago, and they are paying between 5 and 6 percent in my pocket, tax free, every year, verified (I do my own taxes.) Try THAT with a current-issue CD.

The suggestion is that I should get rid of them? I doubt that. Interestingly, when they ARE put up for sale, the buyers are few.

One of my blind spots is that I'm not quite sure of the reason for the illiquidity of an asset like that.
This doesn't pass the smell test. If you are truly earning a coupon above the rate of similar-risk currently issued bonds, you should be able to sell your bonds for a premium. Yeah, the muni market isn't as efficient as the stock market, so you might not fully realize what you'd expect. But if your bonds are as illiquid as you claim, then something is wrong and maybe you have some very high risk or odd-ball type muni.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by theunknowntech »

Allan Roth wrote:
theunknowntech wrote:
But I AM earning 5-6% interest every year on these munis. If you bet against that, you'd be entering into a suckers bet, and that's beneath my dignity. Best regards and respect.

Why would these things be so difficult to sell. Possibly because people are incredulous, dunno.

If you understood what a municipal bond really is on a fundamental level, down to the signature, and really FELT what was going on behind it, you might change your tune.
You may want to consider a couple of biases that could be going on - both overconfidence and confirmation bias. VWIUX currently yields 1.92% but you can earn 3x that amount. The logical conclusion is that you are 3x the muni bond manager that Vanguard is. I'm sorry but I respectfully question that claim and merely suggest you do so as well. Again, much of your perceived income comes from the fact that rates declined and principal values increased - at least that is what I suspect.
The bottom line is that the money comes in, and that's not a matter of dispute. I'm not going to argue with cash in my pocket. This is not theoretical.

Dallas and San Antonio are not municipalities that are going to go belly up any time soon. We're doing just fine, thanks. :^)
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Re: [Allan Roth Says Not to Load Up on Muni Bonds]

Post by LadyGeek »

I corrected the thread title.

For new investors, Allan Roth is in the wiki: Allan Roth

FYI - The OP can change the thread title by editing the Subject: line in Post #1.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by rca1824 »

Artsdoctor wrote:^ I don't think anyone here would be doubting that you're getting a 5% coupon.

One of the issues that many people have, and I'm not saying that would be you, is that your coupon does not usually reflect your yield. I can easily buy an individual bond on the market right now that has a coupon of 5%, but it would be a premium bond (for example, I'd pay $30,000 to buy 25 bonds that would pay me $25,000 on the date of maturity). Many people see that $1,250 of income each year and think they're getting 5%, but they're not taking the amortization into account.

Virtually no one buys a bond at exactly par, even at auction.

Munis are not just illiquid, but the prices are not transparent. It's easier than it used to be, but one could easily give up an entire year of yield by selling at unfair (and typical) price. Take a look at the ask/bid spread and you'll see what I'm talking about.
If you have a long horizon and hence low need for liquidity, then wouldn't it be advantageous to buy illiquid assets, since they would offer an "illiquidity premium"?
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Re: [Allan Roth Says Not to Load Up on Muni Bonds]

Post by Leesbro63 »

LadyGeek wrote:I corrected the thread title.

For new investors, Allan Roth is in the wiki: Allan Roth

FYI - The OP can change the thread title by editing the Subject: line in Post #1.
Thank you. I removed the brackets so it looks like any other thread.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by Artsdoctor »

rca1824 wrote:
Artsdoctor wrote:^ I don't think anyone here would be doubting that you're getting a 5% coupon.

One of the issues that many people have, and I'm not saying that would be you, is that your coupon does not usually reflect your yield. I can easily buy an individual bond on the market right now that has a coupon of 5%, but it would be a premium bond (for example, I'd pay $30,000 to buy 25 bonds that would pay me $25,000 on the date of maturity). Many people see that $1,250 of income each year and think they're getting 5%, but they're not taking the amortization into account.

Virtually no one buys a bond at exactly par, even at auction.

Munis are not just illiquid, but the prices are not transparent. It's easier than it used to be, but one could easily give up an entire year of yield by selling at unfair (and typical) price. Take a look at the ask/bid spread and you'll see what I'm talking about.
If you have a long horizon and hence low need for liquidity, then wouldn't it be advantageous to buy illiquid assets, since they would offer an "illiquidity premium"?
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Re: Allan Roth Says to Avoid Muni Bonds

Post by theunknowntech »

Leesbro63 wrote:
theunknowntech wrote:
Leesbro63 wrote:I guess the article is OK after all, but maybe the title should have been "avoid INDIVIDUAL muni bonds".
Hmmm. I own a bunch of individual munis from a long time ago, and they are paying between 5 and 6 percent in my pocket, tax free, every year, verified (I do my own taxes.) Try THAT with a current-issue CD.

The suggestion is that I should get rid of them? I doubt that. Interestingly, when they ARE put up for sale, the buyers are few.

One of my blind spots is that I'm not quite sure of the reason for the illiquidity of an asset like that.
This doesn't pass the smell test. If you are truly earning a coupon above the rate of similar-risk currently issued bonds, you should be able to sell your bonds for a premium. Yeah, the muni market isn't as efficient as the stock market, so you might not fully realize what you'd expect. But if your bonds are as illiquid as you claim, then something is wrong and maybe you have some very high risk or odd-ball type muni.
The bottom line is, that when it comes to the bond market, people are [slightly less engaged].

This is different from where things stand with equities, which is a much more intellectually engaging subject. You can do all kinds of gymnastics there, and potentially for profit. But when it comes down to bond trading, eyes tend to glaze over. What can you do.

I wouldn't blame people for misunderstanding how the bond market actually works, at the nuts and bolts level. My eyes glaze over too.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by afan »

It is certainly possible the bonds were purchased at pa r back when rates were higher. They have appreciated since as rates have dropped. If one considers the purchase price, not the current market value, they could be "paying 5%"

But I am puzzled why credit quality is not just as big a concern with corporate bonds??? One could advise tilting toward higher quality debt, but why assume corporate issues are broadly safer? Why would a high quality corporate fund have lower default risk than high quality munis?
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by ogd »

theunknowntech wrote:The bottom line is that the money comes in, and that's not a matter of dispute. I'm not going to argue with cash in my pocket. This is not theoretical.
I don't think the argument is about the money in your pocket, it's about the fact that you're probably measuring it the wrong way. That is, you're not really "earning" 5% any more.

I'll do you one better: I can buy today a Treasury (no credit risk) with less than a year left to maturity (little interest rate risk), with a coupon of 7.25%. The catch? The premium I have to pay makes the yield only 0.29% because that premium will be gone by maturity. That means that instead of buying this once-amazing security, or instead of keeping it till maturity if I already have it, I'm better off putting the money in a 1% savings account, better off as in measurably more cash in my pocket.

What is the YtM on your bonds? That's what you're earning. It might be that it is actually in that neighborhood, but I really doubt it since the issuer would have to be in real trouble for anywhere close to 5%.

It's also possible with munis that the spread is so large that the yield compared to what you could actually sell it for is large. I also doubt this variant, but it's possible.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by freebeer »

ogd wrote:
theunknowntech wrote:The bottom line is that the money comes in, and that's not a matter of dispute. I'm not going to argue with cash in my pocket. This is not theoretical.
I don't think the argument is about the money in your pocket, it's about the fact that you're probably measuring it the wrong way. That is, you're not really "earning" 5% any more...
theunknowntech, I think the question we are all getting at is: how exactly are you calculating the principal amount on which you are "earning 5%"? It is a percent of something - what is the something? If it's the original purchase price then that would be like owning a stock currently paying a 2% dividend but claiming you are "earning 5%" because you bought it for $4/share and it's now $10/share. Earnings from an asset are conventionally calculated based on current market value of that asset, not original purchase price, because that's what matters as you compare different risk/return opportunities.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by Artsdoctor »

I believe that the gist of the conversations here reiterate what Allan Roth and others have said all along. Individual bond holders see the income only and often do not appreciate the amortization component of a premium bond.

Larry Swedroe also mentioned a long time ago that individual muni bond holders will fail to offset muni income on their state tax forms from out-of-state bonds by the amount amortized.

Lastly, muni income is counted in modifying your AGI for Medicare premium purposes so if you don't amortize even in-state bonds on your tax return, you can be penalized by needlessly increasing your Medicare premiums. This is a mistake I've even seen accountants make because they don't see the ramifications.

So one of the teaching points that's being made here is that if you don't understand every aspect of individual munis, stay away.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by Jill07 »

Any response to this post from Victoria?
What is the current sweet spot for municipal bond funds? I have some maturing CDs and need to find a place to invest the proceeds. Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (VWITX) now yields 1.83% which is equivalent to 2.5% in CD income in the 28% bracket. Are there any reasons not to invest in it?

Allan's last point in the referenced article is

Allan Roth wrote:
4. Munis may now be tied to the stock market. Over the long run, if stocks do poorly, there could be systemic defaults on munis.


This risk applies to muni funds (such as VWITX) as well as to individual munis. Right?
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by VictoriaF »

While waiting for a response, I read Artsdoctor's post that the income from municipal bonds is added to the AGI and thus does not help with getting into a lower band of the Medicare Part B premiums which are based on the MAGI.

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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by ww340 »

I have a lot of muni bonds that we bought in 2009. Most of those have been called and cashed out. I still have a few left, and I would like to post an example here and ask you to explain what you are saying, because I am not getting it.

I fully believe I am getting 5% or even more on most of my bonds. Here is an example of my holdings, so I would like to have someone explain to me what you mean. I understand that if I pay a premium for a bond, I am not truly getting the yield stated on the coupon, but I have only bought one or two at a small premium that had negligible effect on the rate.

I seriously want to know what I am missing in this discussion, as this comes up frequently on the board and I just don't get it.
I don't want to be delusional in my thinking about bonds, but I feel pretty certain I am receiving in the 5% range on my bonds. If not, please explain it to me

Thanks for your help.



02765UBY9 AMERICAN MUN PWR OH INC REV ASRD GTY B/E OID @99.143 5.45% CPN 5.37500 % MTD 2027-02-15 DTD 2009-03-31
First in, first out (FIFO) 100,000.0000 $1.00 Paid $99,939.51

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059151BA7 BALTIMORE CNTY MD REV CATHOLIC HEALTH INITIATIVES A B/E PTC CPN 5.00000 % MTD 2026-09-01 DTD 2006-11-09
First in, first out (FIFO) 100,000.0000 $0.99 Paid $99,204.95


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442435VV2 HOUSTON TX UTIL SYS REV RFDG COMB 1ST LIEN SER A ASRD GTY B/E OID @96.062 CPN 5.37500 % MTD 2038-11-15 DTD 2009-04-09
First in, first out (FIFO) 100,000.0000 $1.00 Paid $99,991.61

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542264AU0 LONE STAR CLLG SYS TX B/E REOF @99.996 5% CPN 5.00000 % MTD 2029-08-15 DTD 2008-09-01
First in, first out (FIFO) 125,000.0000 $1.00 Paid $124,715.36


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87638TAR4 TARRANT CNTY TX CULTURAL ED FACS FIN CRP REV RFDG HLTH RES A B/E PTC CPN 5.00000 % MTD 2026-02-15 DTD 2007-05-31
First in, first out (FIFO) 100,000.0000 $1.00 Paid $99,647.27
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Artsdoctor
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by Artsdoctor »

442435VV2 HOUSTON TX UTIL SYS REV RFDG COMB 1ST LIEN SER A ASRD GTY B/E OID @96.062 CPN 5.37500 % MTD 2038-11-15 DTD 2009-04-09
First in, first out (FIFO) 100,000.0000 $1.00 Paid $99,991.61

WW,

OK, so what's happening is this. The bond you have above is a AA-rated revenue bond that was originally issued in 2009 at a price of 96.062. That means that those who purchased the bond at auction paid $96,062 for 100 bonds. Those people will be getting 5.375% annually ($5,375) and when the bond matures, they will owe capital gains on the $3,938. They essentially purchased a discount bond. When you buy a bond at a discount, you will essentially have a taxable event if you hold the bond til maturity (although in your case, it would be tiny).

It appears that you purchased all of your bonds at a discount as well and you will owe capital gains on a tiny portion if you hold the bonds until maturity.

You have no bonds that you must amortize.

If I were to buy those Houston utility bonds today, I would have to pay about $109,725. I would still get exactly the same dividend every six months that you get, but I will amortize that bond gradually over the next 23 years, so that my principal will decrease gradually from $109,724 to $100,000 (this will result in a yield to maturity of 2.65%). Since I live in CA, I will declare my tax-exempt income of $5,375 annually but I will offset that income by the amount I amortize the bond that year; that means that I will not have to pay CA state income tax on the full $5,375.
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neurosphere
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by neurosphere »

ww340 wrote:I have a lot of muni bonds that we bought in 2009. Most of those have been called and cashed out. I still have a few left, and I would like to post an example here and ask you to explain what you are saying, because I am not getting it.

I fully believe I am getting 5% or even more on most of my bonds.
Here is the problem. Different people have a different definition of "getting" than you might. I think this is the point that the poster 'theunknowntech' doesn't seem to understand (or perhaps he/she does, but we are misunderstanding him/her).

Here is a completely made up example with ridiculous numbers (and a convoluted story), to emphasize the difference between the coupon (what you receive each year in cash/interest/income) and the yield to maturity (YTM). The coupon is different than the YTM.

Suppose you have a bond which you purchased for $1000, which a couple on 10%. The bond matures in 10 years. If you hold to maturity you will receive $1000 in total interest payments and also get your $1000 back.

But suppose after year 5, there is a wild period of deflation, such that interest rates of various kinds are very negative. In this scenario, that 10% bond is VERY attractive, so attractive that someone might offer you a lot of money for it. For the sake of argument, let's say someone offers you 1 million dollars for that bond. They show up at your home, but a suitcase with $1M on a table, and you put your bond on the table next to it. You can take either the suitcase, or the bond, but not both. In addition, you have 1 day to change your mind after making your decision. Suppose you take the cash. You have $1M. You wake up the next morning and wonder if you made a good decision (you have time to change your mind). Now your decision is this: do you want to pay $1M for a bond which will pay you $100 for the next 5 years, and then return $1000 in principal? Suppose you DID do this. In this case, you paid $1M for $1500 in income+bond value. What is the "yield" of your $1M investment over those 5 years? It's quite low. It's certainly not 10%, even though you bought a bond with a 10% coupon.

Now, back to reality a bit. Suppose you have $100,000 in bonds earning 5% (the coupon). But you could sell the investment today for $110,000. Your YTM is less than 5%. Because in essence every day that you do not sell that bond, you are choosing to "invest" $110,000 for a bond which will only give you back $100,000 at maturity. The 5% coupon is based on the original price, not the current price. And because money is fungible, you are not getting a 5% "yield" on your bond if it is currently worth more than you paid. And when thinking about whether you might sell that bond and buy a different one, it is the yield to maturity of your existing bond vs the new bond which is the relevant metric (assuming equal liquidity, credit risk, etc), and NOT the coupon.

I hope those examples make some sense, even though I can't provide real life examples with real numbers.

NS
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by srj »

I have around 60% of my non-retirement investments in VWIUX (2.8% tax equivalent yield), so this caught my attention:
Though I do own a low-cost muni bond fund, it’s a very small part of my fixed-income portfolio. Muni bonds represent about 10 percent of the U.S. investment-grade bond market and I recommend not having more than twice that percentage in anyone’s portfolio.
Am I nuts then? I'm in the 33% tax bracket and have a short (5-10 year) investment horizon, what else would be appropriate? VWIUX paired with a fund of investment grade corporates?
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by Artsdoctor »

^ No, you're not nuts. Allocating a portion of your portfolio to municipals is something that is very personal. Reading between your lines, though, I wouldn't view my taxable account in isolation--I'd view it as part of your entire investment portfolio. For some people, the taxable account is several times larger than all tax-advantaged accounts combined; for others, it's the opposite.

There are some people who will feel uncomfortable holding all of their fixed income assets in a taxable account in munis and would prefer to add treasuries, CDs, or even corporates to the mix--even if they're in the highest income brackets.

This is a personal decision. The only mistake you can make is not understanding what you're investing in. If, after careful consideration, you choose a path and can understand the pros and cons, then it's probably good enough for you.
Last edited by Artsdoctor on Tue Aug 04, 2015 2:27 pm, edited 1 time in total.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by HueyLD »

srj wrote:I have around 60% of my non-retirement investments in VWIUX (2.8% tax equivalent yield), so this caught my attention:
Though I do own a low-cost muni bond fund, it’s a very small part of my fixed-income portfolio. Muni bonds represent about 10 percent of the U.S. investment-grade bond market and I recommend not having more than twice that percentage in anyone’s portfolio.
Am I nuts then? I'm in the 33% tax bracket and have a short (5-10 year) investment horizon, what else would be appropriate? VWIUX paired with a fund of investment grade corporates?
I respectfully disagree with the quote statement.

How much to invest in munis depends a lot on one's income and asset locations. Higher income and taxable portfolio heavy investors tend to invest proportionally more in munis for obvious reasons. Granted munis are not as safe as Treasuries, but their track record is much better than corporate bonds. If one sticks to high quality GOs and essential services revenue bonds, the safety record is almost as good as the Treasuries.

"One size fits all" solution doesn't really exist in the real world.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by matjen »

srj wrote:I have around 60% of my non-retirement investments in VWIUX (2.8% tax equivalent yield), so this caught my attention:
Though I do own a low-cost muni bond fund, it’s a very small part of my fixed-income portfolio. Muni bonds represent about 10 percent of the U.S. investment-grade bond market and I recommend not having more than twice that percentage in anyone’s portfolio.
Am I nuts then? I'm in the 33% tax bracket and have a short (5-10 year) investment horizon, what else would be appropriate? VWIUX paired with a fund of investment grade corporates?
As others have mentioned, you are not nuts. However, if you want to be a bit safer then look to lessen your VWIUX and put that money into BMBIX. Perhaps there are some tax loss harvesting opportunities with some of the newer funds put into VWIUX? Though remember the rules are a but different for tax loss harvesting with muni funds. In any case, compare the two portfolios. I have put BMBIX's portfolio up earlier in the thread. Here is VWIUX. There is a big difference in quality and advanced refunded holdings.

Image
Last edited by matjen on Tue Aug 04, 2015 5:05 pm, edited 1 time in total.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by larryswedroe »

few quick thoughts
First no reason not to own more than market cap weight of munis, that idea of owning market cap makes no sense to me at all,That's like saying you should only own the market cap weight of stocks. Depends on your situation and tax rate.

Second, there are significant advantages of owning individual munis over muni funds for those that have access to institutional prices and have sufficient size (say $1mm) to diversify sufficiently.

We only use funds for smaller portfolios and liquidity. We get the same or better pricing (we'll buy smaller lots which get better pricing) than does a mutual fund when we buy and we can tailor to state and tax specific situation and can harvest losses at individual level. Note I just bought for myself a 10 year muni that traded about 50 over the curve--was a lot of about 50k (not something a mutual fund would typically buy). And that's not atypical. Also we'll buy taxable secondary CDs for parts of curve where they have higher yields on AT basis than munis, which has often been the case in last few years for certain parts of the curve (typically shorter end). Of course a muni fund would never do that.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by theunknowntech »

freebeer wrote:
ogd wrote:
theunknowntech wrote:The bottom line is that the money comes in, and that's not a matter of dispute. I'm not going to argue with cash in my pocket. This is not theoretical.
I don't think the argument is about the money in your pocket, it's about the fact that you're probably measuring it the wrong way. That is, you're not really "earning" 5% any more...
theunknowntech, I think the question we are all getting at is: how exactly are you calculating the principal amount on which you are "earning 5%"? It is a percent of something - what is the something? If it's the original purchase price then that would be like owning a stock currently paying a 2% dividend but claiming you are "earning 5%" because you bought it for $4/share and it's now $10/share. Earnings from an asset are conventionally calculated based on current market value of that asset, not original purchase price, because that's what matters as you compare different risk/return opportunities.
Just one word Benjamin, just one word: TOLL ROADS.

Let's say I invest 130k in such municipal bonds, several of them, at a 5%+ coupon, and I get back 7k per year, tax free (I live in the same state.) Admittedly, one of them is scheduled for a call in 2017. Because of the concern previously expressed, it's understandable that people would get nervous about calls on them, which is why these things are selling on the bond market for maybe only ten percent above face value.

BUT you've already accumulated that 5%+ per year, for so many years, which is well profitable and beats whatever inflation factored into it, and you will STILL get your original investment back when the call happens.

One of the reasons why people's eyes glaze over at this stuff, is that they make it out to be more complicated than it actually is.

Drive up and down I35 thru the heart of Texas, and see.

It's just a loan basically. It was ever thus.
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Re: Allan Roth Says to Avoid Muni Bonds

Post by hudson »

matjen wrote:Just a reminder that not all muni bond funds are the same. I'm not sure whether this would change Mr. Roth's rule of thumb but since I knew I would have a large slug of muni funds I decided to go with about the safest and most conservative one I could find and that is Baird Intermediate Muni Bond Inst (BMBIX).e

It is much higher quality than most other muni bond funds...including Vanguard's.

Image

http://portfolios.morningstar.com/fund/ ... ture=en_US
BMBIX has been a Boglehead favorite...over 50% Prefunded. Vanguard's VWIUX has little or no prefunded bonds. Matjen's image uses the term "Advanced Refunded"

Here's a BMBIX fact sheet from Baird's website: http://content.rwbaird.com/BairdFunds/P ... -sheet.pdf

Larry Swedroe speaks to munis and risk: viewtopic.php?p=1990277#p1990277
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by ww340 »

Artsdoctor and neurosphere, thank you both for trying to educate me. I have gained some insight from both of your posts. As well as the rest of the discussion on municipal bonds.

My question when looking at the yield I might be losing by not selling today, while it is worth more, is that there does not seem to be a better place to put the money. I certainly cannot buy a bond today with a 5% coupon without paying a similar premium. CD's and treasuries don't appeal to me with those low rates. So I would appreciate an idea of how I would improve my lot today by selling that bond now for a profit.

I can understand that some year in the future my bond will be worth less than I paid, because of changes in interest rates and inflation. I also could see if I was planning to consume the amount of the bond in the near future, that it would behoove me to sell it today.

I have invested some money in Vanguard's intermediate muni fund and the high yield muni fund. I have lost money in both of those so far since I invested. Now, I wouldn't have lost much if I had reinvested the dividends, but we use the muni interest for spending. If I have to continually reinvest the dividend to stay even, it does not seem to be much of a benefit.

I invested in them so that I could actually see how the funds work in comparison to the individual bonds. So far I am not seeing the benefit of the funds beyond liquidity.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by Artsdoctor »

WW,

You are now asking the fundamental question of: which is better, an individual bond or a bond fund? There are two places which will give you plenty of information right off the bat: here on the Wiki; and, Vanguard has written several papers on this very topic which you can find on their website.

You have to be careful that you're comparing apples to apples. In 2009, you bought individual bonds with enticing yields but they were 30-year bonds. The bond is now trading at a premium (about 10% higher than when you bought it). As current interest rates go back up, the principal will fall. But if you hold the bond to maturity, you will get the par value. Of course, $100,000 in purchasing power when the bond matures will be very different than it is now.

You describe a loss of principal to your fund, and as interest rates rise, this will occur. But it would have occurred if you had bought that individual bond as well (perhaps the loss would have been greater since it's duration is much longer than your fund's).

Understanding bonds, I find, is difficult because there are a lot of moving pieces, and one person's reasons for holding a bond (or fund) may not be the same as another's.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by LadyGeek »

Artsdoctor wrote:WW,

You are now asking the fundamental question of: which is better, an individual bond or a bond fund? There are two places which will give you plenty of information right off the bat: here on the Wiki; and, Vanguard has written several papers on this very topic which you can find on their website...
Here's the wiki part: Individual bonds vs a bond fund

The bottom of the article has several Vanguard white papers (this is a popular topic).
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ww340
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by ww340 »

Thank you Artsdoctor and LadyGeek.

I have read the wiki on the subject before, and I will read it again. I am afraid I am really thick on this particular subject. But I truly do want to understand it.
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Re: Allan Roth Says Not to Load Up on Muni Bonds

Post by ogd »

ww340 wrote: My question when looking at the yield I might be losing by not selling today, while it is worth more, is that there does not seem to be a better place to put the money. I certainly cannot buy a bond today with a 5% coupon without paying a similar premium. CD's and treasuries don't appeal to me with those low rates. So I would appreciate an idea of how I would improve my lot today by selling that bond now for a profit.
Hi ww340,

The essence of the argument is this:

1) If the bond is currently trading at a premium, you will relinquish that premium by waiting until maturity. The YtM of the bond (lower than 5%) takes that into account. In some cases, like my Treasury example above (7.5% coupon, close to maturity, 0.29% yield), the loss of premium is so severe that it actually makes more sense to put the money in a 1% savings account, becase no matter what happens you will end up with more money. This is not dependent on interest rates going anywhere.

The yield means the return of holding the bond based on current price, because that's the level at which you can exchange into an alternative. If you define your "earnings" based on the initial price or par value you can end up with the paradoxical situation that a Treasury that "earns" 7.5% is handily beaten by a savings account that earns 1%.

Another way to think about this is that your bond used to yield 5%, but it's returned most of that early in its lifetime and what's left is significantly less. It was certainly a good buy. But sometimes it makes sense to just take those returns and move on. Bond prices and yields should not be thought of as fixed, but ever-changing.

I should also add -- and please don't take this the wrong way -- that in my opinion these notions need to be second nature for anyone going into individual bonds. Particularly munis, with complex call features that seem to be designed to trap (or trip) the amateur investor into making a suboptimal investment.

2) If the bond is actually trading at par or below, meaning a 5%+ yield, it must be very risky. In this case the main threat is that of a default or haircut. There are many well-informed professionals that would be willing to pay a higher price (and lower the yield) if that weren't so.

Hope this helps.
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