Larry Swedroe: What Drives Municipal Bond Yields

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Random Walker
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Larry Swedroe: What Drives Municipal Bond Yields

Post by Random Walker »

https://www.advisorperspectives.com/art ... ond-yields

In this article Larry shows that high quality Municipal Bond yields are perhaps higher than many of us would expect relative to Treasury yields. This apparently is largely due to a liquidity premium. For those interested in using tax advantaged space for other tax inefficient assets, municipal bonds in the taxable portion of the portfolio rather than treasuries in the tax deferred makes great sense to me.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by PFInterest »

funny i never picked munis for their yield. i do it for their tax efficiency. and also by buying VWIUX at Vanguard....i dont think there EVER will be a liquidity issue.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Blue »

Beyond liquidity and credit risk, it seems like there is also the risk of change in tax policy/rate?
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by bligh »

Blue wrote:Beyond liquidity and credit risk, it seems like there is also the risk of change in tax policy/rate?
Agreed that does worry me... If the municipal bonds interest ever became taxable you'd see a sharp adjustment in the yield to reflect that. Even if the probability of such an event is low, it still needs to be considered.

Another possibility that could affect the value of the municipal bonds is if the current administration is able to push through the $1 Trillion infrastructure plan it is currently proposing. Someone correct me if I'm wrong, but depending on how such a plan is financed, could it not flood the municipal bond market with a flood of new bonds, thereby pushing yields up?
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by grabiner »

An interesting point:
Many investors can bear liquidity risk, because they buy individual bonds with the intent of holding them to maturity. For them liquidity is not a major risk, at least in some portion of their portfolio; the reduced liquidity in the market makes municipal bonds more attractive.
If you know that you won't need the money for ten years, you can buy a ten-year bond, and not worry about the liquidity premium.

Muni ETFs also mostly avoid the liquidity premium, as they don't need to buy and sell illiquid securities. If there are liquidity issues, muni ETFs may trade at a discount, but buy-and-hold investors won't be hurt. Muni funds might be slightly affected by trading costs, but they can hold enough liquid munis to reduce the risk, intending to keep the less liquid bonds until maturity or until the liquidity improves.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Random Walker »

Seems to me that for the individual investor the liquidity premium is an easy one to catch. While the market looks at liquidity as the ability to trade daily or maybe even hourly, the individual investor knows very well his own time frame for the money, liquidity requirements, and potential liquidity from other parts of the portfolio. Seems to me that with any sort of long term plan and a modest cushion, the individual investor should jump on this liquidity premium in particular and consider other liquidity Premia that might be available. The ability to sell maybe 3-5X a year may not be very liquid as far as the market is concerned, but is likely quite liquid enough for the individual.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by dratkinson »

bligh wrote:
Blue wrote:Beyond liquidity and credit risk, it seems like there is also the risk of change in tax policy/rate?
Agreed that does worry me... If the municipal bonds interest ever became taxable you'd see a sharp adjustment in the yield to reflect that. Even if the probability of such an event is low, it still needs to be considered.
Change in muni tax policy. As a novice investor I've thought about this. For munis to become taxable, it would require that 50 state governors, and the representatives and senators elected from those states and who make our laws, to agree that all states will pay more to service their debt.

My simplifying assumptions. Who will take the hit, the states by paying more to service debt, or the federal government with less tax revenue?
--Given that elected official from those states make this decision, I don't think the fed government stands any chance of avoiding the hit.
--Plus! TE munis give all elected officials a place to stash their (taxable account) cash to protect it from the fed government. RQ: Who would not vote to continue giving themselves a personal tax loophole?

I could be wrong, but will not worry about it until muni legislation changes. Then will reevaluate the rising yield of the then taxable munis against other taxable bond options. Or maybe taxable munis will then be merged into TBM and the issue will become moot.

Bottom line. Nothing to worry about today.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by jbolden1517 »

bligh wrote:
Blue wrote:Beyond liquidity and credit risk, it seems like there is also the risk of change in tax policy/rate?
Agreed that does worry me... If the municipal bonds interest ever became taxable you'd see a sharp adjustment in the yield to reflect that. Even if the probability of such an event is low, it still needs to be considered.

Another possibility that could affect the value of the municipal bonds is if the current administration is able to push through the $1 Trillion infrastructure plan it is currently proposing. Someone correct me if I'm wrong, but depending on how such a plan is financed, could it not flood the municipal bond market with a flood of new bonds, thereby pushing yields up?
$1t is not that much for the bond market. State and federal tax exempt (especially AMT) is a huge benefit. There are ceilings that would be hit pretty quickly. There are lots of people like myself in high tax brackets who would liked tax free fixed income that don't currently hold municipals because of yield. I wouldn't want to take on duration risk, but if yields were higher I'd be shorting taxable interest instruments to collect tax free interest on bonds of the same maturity/duration. Now if it were $10t then it likely would push up all yields. But I still think municipals would keep their advantages.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by baw703916 »

Nice article by Larry, and it makes a point that I've been arguing on this board for quite a while: that for about a decade now, yields on high grade munis have been comparable (and often higher) than Treasuries of equal maturity. So why does the conventional dogma about bonds in tax-advantaged still persist as a blanket statement. The liquidity premium is often a real consideration for institutional investors, but for individuals, it may be a free lunch (depending on their situation).

One minor quibble I have is on the assumption of the effective tax rate of 40% in the second paragraph. Things like phaseouts and AMT may complicate things quite a bit, but if one if comparing Treasuries (as opposed to corporate bonds) with munis, the Treasuries aren't taxable at the state level. You're much more likely to get to a 40% effective marginal tax rate if state taxes are also in play.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Theoretical »

I think the trickier problem is that until you reach Larry's 10 issuer x 50 bond threshold, it becomes really difficult to diversify or have ANY liquidity in the fixed income, especially if you've got 5 bond clumps.

What makes an interesting workaround is iShares target date maturity muni funds.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Kevin M »

The highest yield I see on an AAA 10-year muni at Vanguard is 1.85%. Assuming muni bonds are priced to be competitive at a 25% marginal tax rate, that's a taxable-equivalent yield of 2.47% (1.85% / 0.75). Yield on the 10-year Treasury is 2.24%, so that's a taxable-equivalent yield (TEY) premium of 23 basis points.

There are only 10 bonds available at this yield, and the next yield is 1.80%, so TEY = 2.40% for TEY premium of 16 bps.

Every AAA muni I see at Vanguard is callable, and Larry often mentions that callability is a negative, so there should be some premium for this.

And of course there's still Larry's additional criteria that these bonds may or may not meet (GO, essential services, etc.).

Perhaps this happens to be a time when the muni yield premium is not rich.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Case59 »

Kevin M wrote:The highest yield I see on an AAA 10-year muni at Vanguard is 1.85%. Assuming muni bonds are priced to be competitive at a 25% marginal tax rate, that's a taxable-equivalent yield of 2.47% (1.85% / 0.75). Yield on the 10-year Treasury is 2.24%, so that's a taxable-equivalent yield (TEY) premium of 23 basis points.

There are only 10 bonds available at this yield, and the next yield is 1.80%, so TEY = 2.40% for TEY premium of 16 bps.

Every AAA muni I see at Vanguard is callable, and Larry often mentions that callability is a negative, so there should be some premium for this.

And of course there's still Larry's additional criteria that these bonds may or may not meet (GO, essential services, etc.).

Perhaps this happens to be a time when the muni yield premium is not rich.

Kevin
Kevin,

Why is the distribution yield of Vanguard's intermediate and LT muni funds so much higher than the SEC yield? 2.81% v. 1.87% for VWIUX, 3.57% v. 2.47% percent for VWLUX.

Is this an argument for using the funds instead of individual bonds, especially if you live in a state where there's not much opportunity for in-state munis?
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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Case59,
Could the distribution yield include return of principal when the bonds mature?

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Re: Larry Swedroe: What Drives Municipal Bond Yields

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Reading the original paper linked in Larry’s article, the dramatic change in muni market spreads relative to Treasuries since the 2008 Financial Crisis is rather remarkable (chart below):
Ang, Bahnsali and Xing wrote:We find that before 2008, the muni spread averaged -0.87% and there was a pronounced shift in the behavior of the spread after the financial crisis. After 2008, the muni spread flips sign to 0.87%.

The liquidity component is mostly responsible for the change in the level of the muni spread: from 1996 to 2007, the average muni liquidity component is 0.82% compared to 2.14% after 2008. The credit component does not change very much, moving from 0.40% to 0.57% in the pre- and post-2008 samples. The tax component is also relatively stable at -2.09% before 2008 and -1.84% afterwards.
(edited out extraneous comments). It seems like a rather historic shift in the U.S. domestic bond market.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by columbia »

Interesting discussion.
It's unfortunate that Larry isn't around. :confused
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by zaboomafoozarg »

I recently reached a point where I wasn't concerned about free lunch or not - my taxable account had nothing but stock funds in it and was finally worth enough that I felt some balance was necessary there.

So lately I've been buying Vanguard's intermediate-term tax-exempt bond fund in my taxable account. It makes balancing my AA between tax-advantaged and taxable accounts easier.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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Case59 wrote:Why is the distribution yield of Vanguard's intermediate and LT muni funds so much higher than the SEC yield? 2.81% v. 1.87% for VWIUX, 3.57% v. 2.47% percent for VWLUX?
Because interest rates have fallen. If a bond is purchased at par for $1000 with a 4% yield, it will pay a coupon of $40 per year. If the bond has a 10-year duration and rates fall to 3%, the bond will be worth $1100. It will have a 3% yield to maturity (which determines the SEC yield), but a 3.64% coupon yield (which determines the distribution yield). If you hold the bond to maturity, its price will decline back from $1100 to $1000, but you make up that loss in higher coupon payments than you would get on a bond worth $1100 with a $33 coupon.

Thus, if a fund has a higher distribution yield than its SEC yield, you expect its share price to decline even if interest rates stay the same; your expected return is still the SEC yield.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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baw703916 wrote:Nice article by Larry, and it makes a point that I've been arguing on this board for quite a while: that for about a decade now, yields on high grade munis have been comparable (and often higher) than Treasuries of equal maturity. So why does the conventional dogma about bonds in tax-advantaged still persist as a blanket statement. The liquidity premium is often a real consideration for institutional investors, but for individuals, it may be a free lunch (depending on their situation).
The usual comparison is between munis and corporates. Vanguard Intermediate-Term Tax-Exempt yields 1.87% on Admiral shares, and Intermediate-Term Investment-Grade yields 2.71%. The difference of 0.85% isn't entirely a tax cost for holding the muni fund, as it is probably less risky, with Intermediate-Term Investment-Grade holding 23% in bonds rated BBB and 3% in junk or unrated bonds, versus 6% and 2% for Intermediate-Term Tax-Exempt.

My rule of thumb is that munis are priced to break even with corporate bonds of comparable risk in a 25% bracket, which would make the effective tax cost on Intermediate-Term Tax-Exempt 0.62%. Depending on your state tax rate, and on how much you expect to pay in capital gains, that could still be comparable to the tax cost of a stock index. At current yields, I normally recommend munis in taxable if you are in a high-tax state and Vanguard has a fund for your state, or if you are in the top tax bracket and thus pay 23.8% federal tax on qualified dividends. (Neither condition applies to me; Vanguard does not have a MD fund, and T. Rowe Price's MD fund costs more in expenses than it saves in taxes.)
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Random Walker »

Zaboomafoozarg,
I agree. Need at list one asset class that is the same (or largely the same) in both taxable and tax advantaged accounts to maintain the desired AA. I think there's frequently a point where individuals have to accept something less than perfect asset location for the sake of the asset allocation they want.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

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grabiner wrote: your expected return is still the SEC yield.
+1
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Case59 »

grabiner wrote:
Case59 wrote:Why is the distribution yield of Vanguard's intermediate and LT muni funds so much higher than the SEC yield? 2.81% v. 1.87% for VWIUX, 3.57% v. 2.47% percent for VWLUX?
Because interest rates have fallen. If a bond is purchased at par for $1000 with a 4% yield, it will pay a coupon of $40 per year. If the bond has a 10-year duration and rates fall to 3%, the bond will be worth $1100. It will have a 3% yield to maturity (which determines the SEC yield), but a 3.64% coupon yield (which determines the distribution yield). If you hold the bond to maturity, its price will decline back from $1100 to $1000, but you make up that loss in higher coupon payments than you would get on a bond worth $1100 with a $33 coupon.

Thus, if a fund has a higher distribution yield than its SEC yield, you expect its share price to decline even if interest rates stay the same; your expected return is still the SEC yield.
Thanks, that makes sense.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by zaboomafoozarg »

Random Walker wrote:Zaboomafoozarg,
I agree. Need at list one asset class that is the same (or largely the same) in both taxable and tax advantaged accounts to maintain the desired AA. I think there's frequently a point where individuals have to accept something less than perfect asset location for the sake of the asset allocation they want.

Dave
Yeah, it meant a little more complexity from extra holdings, but I was running out of room in my IRA so this makes things better.

Of course if I didn't tilt so much this would be a lot easier :D
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by LadyGeek »

With regards to an earlier question on proposed government spending on infrastructure, speculation on proposed legislation is off-topic. See: Re: Tax exempt muni bond funds & proposed lower rates on taxable investment interest

Please stay focused on the investing aspects.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by raven15 »

grabiner wrote:
baw703916 wrote:Nice article by Larry, and it makes a point that I've been arguing on this board for quite a while: that for about a decade now, yields on high grade munis have been comparable (and often higher) than Treasuries of equal maturity. So why does the conventional dogma about bonds in tax-advantaged still persist as a blanket statement. The liquidity premium is often a real consideration for institutional investors, but for individuals, it may be a free lunch (depending on their situation).
The usual comparison is between munis and corporates. Vanguard Intermediate-Term Tax-Exempt yields 1.87% on Admiral shares, and Intermediate-Term Investment-Grade yields 2.71%. The difference of 0.85% isn't entirely a tax cost for holding the muni fund, as it is probably less risky, with Intermediate-Term Investment-Grade holding 23% in bonds rated BBB and 3% in junk or unrated bonds, versus 6% and 2% for Intermediate-Term Tax-Exempt.

My rule of thumb is that munis are priced to break even with corporate bonds of comparable risk in a 25% bracket, which would make the effective tax cost on Intermediate-Term Tax-Exempt 0.62%. Depending on your state tax rate, and on how much you expect to pay in capital gains, that could still be comparable to the tax cost of a stock index. At current yields, I normally recommend munis in taxable if you are in a high-tax state and Vanguard has a fund for your state, or if you are in the top tax bracket and thus pay 23.8% federal tax on qualified dividends. (Neither condition applies to me; Vanguard does not have a MD fund, and T. Rowe Price's MD fund costs more in expenses than it saves in taxes.)
I think you over estimate the risk in muni's. Intermediate Term Investment Grade has been most nearly similar to High Yield Tax Exempt in terms of risk (though the high yield fund may have extension risk because of its longer maturity which has not shown up in recent decades). Intermediate Term Tax Exempt has shown clearly less risk, roughly similar to 75% Intermediate Treasury 25% LQD, at least in terms of maximum draw down, though it far less volatility. Thau in "The Bond Book" notes that municipal bonds of the same credit rating are substantially less risky than corporate bonds.

Portfolio Visualizer demonstration of this:
https://www.portfoliovisualizer.com/bac ... tion4_3=75
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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Could you use the Vanguard limited term tax exempt bond fund. Holds bonds for average 2 yrs. If someone was looking to try to just stay up with this low inflation. Meaning better than savings bank or lock in 5 yr cd.

Money that you don't want to invest but would like to make a little better than savings. Also, money not needed now but could be in 3-5 years. This is the unknown money sitting in savings. Not the emergency fund.

What would be the negative results if market changes or interest rate that I believe can only go up from here.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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indexonlyplease wrote:Could you use the Vanguard limited term tax exempt bond fund. Holds bonds for average 2 yrs. If someone was looking to try to just stay up with this low inflation. Meaning better than savings bank or lock in 5 yr cd.

Money that you don't want to invest but would like to make a little better than savings. Also, money not needed now but could be in 3-5 years. This is the unknown money sitting in savings. Not the emergency fund.

What would be the negative results if market changes or interest rate that I believe can only go up from here.
One way to answer the last question is to look at the drawdowns using Portfolio Visualizer: Backtest Portfolio Asset Allocation (click on Drawdowns). Note that this is for monthly returns, so drawdowns could be worse looking at daily returns.

We see that the maximum drawdown was -2.12%, starting on 8/2016, hitting the low point at the end of 11/2016, and recovering at the end of 5/2017. So you were under water for 10 months.

SEC yield for investors shares is 1.23%, and for admiral shares it's 1.33%. Assuming muni bonds are priced to be competitive with taxable bonds in the 25% tax bracket, the taxable equivalent yield (TEY) for investor shares is 1.23% / 0.75 = 1.64%. You can get a no-penalty 11-month CD from Ally Bank with an APY of 1.50% for $25K minimum, so you're only getting 14 basis points of TEY in return for the risk of losing 2% if interest rates increase as much as they did from August 2016 through November 2016.

If you're in a higher tax bracket, then the yield premium over the no-penalty CD is higher, and you can assess if you feel it's adequate compensation for the extra risk.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by bberris »

The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

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bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
it's a great point.

take the vanguard long term tax exempt bond fund for example.
https://personal.vanguard.com/us/funds/ ... 0043#tab=0
It has an average duration of 7 years but average maturity of 16.7 years. That highlights the issue you raise. the bonds have been priced towards those calls being made. If interest rates rise, some of them may not be and the funds duration will likely extend. Investors then get a double whammy from rising interest rates.

for example say interest rates rise by 2% points. Based on the duration of 7, investors might expect to lose 14% (=7 x 2% point rise). but if the duration extends to 8 or so as rates rise then investors might lose 16% (=8 x 2% point rise).

The traditional way call risk is assessed mathematically is through convexity. Unfortunately Vanguard does not publish convexity estimates for their bond funds. We can estimate it by looking at the index the Vanguard long term fund tracks: the Bloomberg muni index. As per Bloomberg, this index has a convexity of -0.77. So again if we look at a 2% point rise in interest rates the fund might lose...

est loss in % points = -duration * rate-rise +1/2*convexity*(rate-rise)^2

est. loss in %points = -7*2 + 0.5 * (-0.77)*2^2 = -15.5%
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by indexonlyplease »

Kevin M wrote:
indexonlyplease wrote:Could you use the Vanguard limited term tax exempt bond fund. Holds bonds for average 2 yrs. If someone was looking to try to just stay up with this low inflation. Meaning better than savings bank or lock in 5 yr cd.

Money that you don't want to invest but would like to make a little better than savings. Also, money not needed now but could be in 3-5 years. This is the unknown money sitting in savings. Not the emergency fund.

What would be the negative results if market changes or interest rate that I believe can only go up from here.
One way to answer the last question is to look at the drawdowns using Portfolio Visualizer: Backtest Portfolio Asset Allocation (click on Drawdowns). Note that this is for monthly returns, so drawdowns could be worse looking at daily returns.

We see that the maximum drawdown was -2.12%, starting on 8/2016, hitting the low point at the end of 11/2016, and recovering at the end of 5/2017. So you were under water for 10 months.

SEC yield for investors shares is 1.23%, and for admiral shares it's 1.33%. Assuming muni bonds are priced to be competitive with taxable bonds in the 25% tax bracket, the taxable equivalent yield (TEY) for investor shares is 1.23% / 0.75 = 1.64%. You can get a no-penalty 11-month CD from Ally Bank with an APY of 1.50% for $25K minimum, so you're only getting 14 basis points of TEY in return for the risk of losing 2% if interest rates increase as much as they did from August 2016 through November 2016.

If you're in a higher tax bracket, then the yield premium over the no-penalty CD is higher, and you can assess if you feel it's adequate compensation for the extra risk.

Kevin
I read above again. I get it. Yes, not much better but more risk. CD would be better.

After 2009 the returns have not been great either. So, I am in the 25% tax bracket. A 5 yr cd paying 2.3% would be better even after taxes?? But I would have to look at the intermediate bonds and do the division.
Also, the worst part is that I could cash in the cd and just lose the interest. Depending on penalty of course.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Kevin M »

indexonlyplease wrote:So, I am in the 25% tax bracket. A 5 yr cd paying 2.3% would be better even after taxes??
Just from a taxable equivalent yield perspective, yes. However, a 5-year brokered CD has more term risk, especially during the first couple of years.
Also, the worst part is that I could cash in the cd and just lose the interest. Depending on penalty of course.
Yes, a good 5-year direct CD has less downside risk than the limited term fund. I believe there is a 5-year available at 2.3% with an early withdrawal penalty (EWP) of six months of interest, limiting downside to about -1.15%. Or you can get one at 2.5% with an EWP of one year of interest, for a max downside of -2.5%.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Kevin M »

indexonlyplease wrote:But I would have to look at the intermediate bonds and do the division.
SEC yield on Vanguard intermediate-term tax-exempt investor shares (VWITX), is 1.77%, so that's a TEY of 2.36% (= 1.77% / 0.75); average duration is 5.2 years, and average stated maturity is 8.4 years. Max drawdown for VWITX was -6.79%. I think the risk/return favors a good 5-year direct CD, but of course you could own some of each.

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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by indexonlyplease »

Kevin M wrote:
indexonlyplease wrote:But I would have to look at the intermediate bonds and do the division.
SEC yield on Vanguard intermediate-term tax-exempt investor shares (VWITX), is 1.77%, so that's a TEY of 2.36% (= 1.77% / 0.75); average duration is 5.2 years, and average stated maturity is 8.4 years. Max drawdown for VWITX was -6.79%. I think the risk/return favors a good 5-year direct CD, but of course you could own some of each.

Kevin
Really good information. This is just some money I don't want to risk right now in the market. My investments are maxed out. Do investors like us use cd for short term less that 5 years. I can't imagine having everything in the market besides your emergency fund.

My thinking is just keeping up with inflation for now. Until some purchase comes up one day. I have plenty being invested.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Kevin M »

indexonlyplease wrote:Do investors like us use cd for short term less that 5 years.
Sure. I have about 75% of my fixed income in direct CDs, and I have about 70% of my portfolio in fixed income. I'm way on the conservative side as forum members go, but I figured out some years ago that I don't need to take much if any stock risk to meet my financial objectives. Then I learned about 6.5 years ago that I could earn intermediate-term yields with short-term risk with direct CDs.

I think the best short-term CD deal is the Ally 11-month no-penalty CD at 1.5%. You earn the same yield as a 3-year Treasury, but without the associated term risk, and as with the Treasury, no credit risk. You can earn 2% on a 3-year CD. You can basically tune your CD holdings to whatever term risk and return you want in the 1.5-2.5% range for CDs with maturities up to five years.

Kevin
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by White Coat Investor »

PFInterest wrote:funny i never picked munis for their yield. i do it for their tax efficiency. and also by buying VWIUX at Vanguard....i dont think there EVER will be a liquidity issue.
That's a weird statement. You can get a lot of tax efficiency just putting your money under the mattress if you don't care about the return on your money. No return, no tax due = super tax efficient.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by PFInterest »

White Coat Investor wrote:
PFInterest wrote:funny i never picked munis for their yield. i do it for their tax efficiency. and also by buying VWIUX at Vanguard....i dont think there EVER will be a liquidity issue.
That's a weird statement. You can get a lot of tax efficiency just putting your money under the mattress if you don't care about the return on your money. No return, no tax due = super tax efficient.
its meant in the setting of being in a high tax bracket...they are good enough. i dont quibble over a few basis points difference if the after tax yield justifies the increased risk compared to TBM.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by indexonlyplease »

Kevin M wrote:
indexonlyplease wrote:Do investors like us use cd for short term less that 5 years.
Sure. I have about 75% of my fixed income in direct CDs, and I have about 70% of my portfolio in fixed income. I'm way on the conservative side as forum members go, but I figured out some years ago that I don't need to take much if any stock risk to meet my financial objectives. Then I learned about 6.5 years ago that I could earn intermediate-term yields with short-term risk with direct CDs.

I think the best short-term CD deal is the Ally 11-month no-penalty CD at 1.5%. You earn the same yield as a 3-year Treasury, but without the associated term risk, and as with the Treasury, no credit risk. You can earn 2% on a 3-year CD. You can basically tune your CD holdings to whatever term risk and return you want in the 1.5-2.5% range for CDs with maturities up to five years.

Kevin
I like that the thinking. I am in the same way. I have enough investment that I have not touched and a good pension we live off. I have a higher stock allocation but somtimes I think about lowering because I have enough and like you stay why take the risk.

I will look into the cd's. You gave me a good idea of what I need. I will maybe buy a few at differnet years. Just try to keep above inflation. Lucky now it really low. Do you ladder cd and is this something for the long term. Or can you just ladder cd's up to 5 yrs and then end.

If I am correct I would need a cd paying around 2% to keep with inflation??

Hope I don't seem to personal. Just interested in investing ideas I never thought of.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by neurosphere »

grok87 wrote:
bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
it's a great point....
Of course, those who hold munis in a rising rate environment can mitigate the risk somewhat with tax loss harvesting. For most people, those holding munis should be in the higher brackets where TLH has a relatively large benefit (compared to those in lower brackets). TLH is not an option for treasury bonds held in retirement accounts.

NS
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Artsdoctor »

bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
Not at all. There are plenty of munis that are not callable. Hopefully, the investor picks the appropriate bonds when purchasing them at auction or on the secondary market. I have many individual munis and nearly all of them are non-callable; those that are have call dates about 1 year before the maturity date. However, your more general point is very well-taken: most people buying individual munis are not aware of call dates, sink dates, premium amortization, discount tax ramifications, and much much more.

Larry's point has always been clear. The "little guy," meaning you and me, will always suffer when trying to sell individual (muni) bonds on the secondary market. Consequently, you should always buy individual munis with the expectation that you'll hold them until maturity. The time-honored practice of tax-loss harvesting individual munis in a rising rate environment should only be applied to those able to sell in large blocks (like through your advisor); otherwise, you're very unlikely to get a decent price. Exceptions may occur, of course; however, the expectation is such that small lots will not get a fair price in a sale.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Random Walker »

One of the many reasons I chose to change from do it yourself to using an advisor was to take advantage of a municipal bond ladder rather than a bond fund. With an advisor, I have a ladder tailored to my individual state tax circumstance, have more control over quality and duration than with a fund, avoid the expense ratio of funds, have access to institutional pricing, don't get tripped up by things I don't understand, and have the opportunity for tax loss harvesting.

Dave
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Kevin M »

indexonlyplease wrote: I will look into the cd's. You gave me a good idea of what I need. I will maybe buy a few at differnet years. Just try to keep above inflation. Lucky now it really low. Do you ladder cd and is this something for the long term. Or can you just ladder cd's up to 5 yrs and then end.

If I am correct I would need a cd paying around 2% to keep with inflation??

Hope I don't seem to personal. Just interested in investing ideas I never thought of.
I think we're getting too far off topic here, so I will PM you answers to your questions.

Kevin
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by bberris »

Artsdoctor wrote:
bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
Not at all. There are plenty of munis that are not callable. Hopefully, the investor picks the appropriate bonds when purchasing them at auction or on the secondary market. I have many individual munis and nearly all of them are non-callable; those that are have call dates about 1 year before the maturity date. However, your more general point is very well-taken: most people buying individual munis are not aware of call dates, sink dates, premium amortization, discount tax ramifications, and much much more.

Larry's point has always been clear. The "little guy," meaning you and me, will always suffer when trying to sell individual (muni) bonds on the secondary market. Consequently, you should always buy individual munis with the expectation that you'll hold them until maturity. The time-honored practice of tax-loss harvesting individual munis in a rising rate environment should only be applied to those able to sell in large blocks (like through your advisor); otherwise, you're very unlikely to get a decent price. Exceptions may occur, of course; however, the expectation is such that small lots will not get a fair price in a sale.
Thanks for the clarification of my exaggeration. And there may be a callable treasury too. My point was to explain the average rates on munis versus the treasury rate, because that was the point of the Swedroe article.
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by grok87 »

neurosphere wrote:
grok87 wrote:
bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
it's a great point....
Of course, those who hold munis in a rising rate environment can mitigate the risk somewhat with tax loss harvesting. For most people, those holding munis should be in the higher brackets where TLH has a relatively large benefit (compared to those in lower brackets). TLH is not an option for treasury bonds held in retirement accounts.

NS
Interesting point
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Re: Larry Swedroe: What Drives Municipal Bond Yields

Post by Artsdoctor »

bberris wrote:
Artsdoctor wrote:
bberris wrote:The article is silent on the big one to me, calls. Almost all munis are callable, treasuries never. So the buyer of a muni takes almost all the risk of rising interest rates and gets almost no benefit from falling interest rates.
Not at all. There are plenty of munis that are not callable. Hopefully, the investor picks the appropriate bonds when purchasing them at auction or on the secondary market. I have many individual munis and nearly all of them are non-callable; those that are have call dates about 1 year before the maturity date. However, your more general point is very well-taken: most people buying individual munis are not aware of call dates, sink dates, premium amortization, discount tax ramifications, and much much more.

Larry's point has always been clear. The "little guy," meaning you and me, will always suffer when trying to sell individual (muni) bonds on the secondary market. Consequently, you should always buy individual munis with the expectation that you'll hold them until maturity. The time-honored practice of tax-loss harvesting individual munis in a rising rate environment should only be applied to those able to sell in large blocks (like through your advisor); otherwise, you're very unlikely to get a decent price. Exceptions may occur, of course; however, the expectation is such that small lots will not get a fair price in a sale.
Thanks for the clarification of my exaggeration. And there may be a callable treasury too. My point was to explain the average rates on munis versus the treasury rate, because that was the point of the Swedroe article.
The point of Larry's article was this.

Traditionally, comparing munis to treasuries show that the yield of a comparable muni to a treasury is about 80%. That would be kind of like saying that a 10-year treasury might yield 2% while a 10-year high-quality muni might yield 1.6%. This is a pretty typical ratio historically, give or take.

The question posed is why is the comparable muni yielding more. There have been times in the recent past when a high-quality muni may have been yielding MORE than its comparable treasury. This is very unusual, and he attempted to answer the question. It's not all about credit quality because even refunding munis guaranteed with treasuries (SLUGS here), are still yielding much more than anticipated.

Larry's answer is reasonable. It's about liquidity. Treasuries are traded daily in very high volume. Munis, however, are not. So you may be making more money with those high-quality munis, but you probably won't be able to trade them fairly.

There are no callable treasuries anymore.
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