2-year AA Munis at Vanguard and Fidelity Today

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Artsdoctor
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Artsdoctor » Sat Apr 14, 2018 7:21 pm

I like: Yes, it was in response to the previous question. Bond ladders can have a place in some investors' portfolios, so don't feel as if your voice is being drowned out.

Hudson: Your question is a fundamental fixed income question. The Wiki here can give you explanations regarding pricing and yields of bonds, if you're interested.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sat Apr 14, 2018 7:22 pm

hudson wrote:
Sat Apr 14, 2018 7:11 pm
Artsdoctor wrote:
Sat Apr 14, 2018 6:54 pm
The bond in question may indeed have a coupon of 5%. It's a premium bond and if the yield to maturity is under 2%, the premium is going to be high. But that's another conversation altogether.
Your insight is appreciated!
I do not understand how the yield can go from 5% to 2%.
You are paying a premium for the bond. So the coupon rate is diluted.

Mydanyale
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mydanyale » Sat Apr 14, 2018 7:44 pm

hudson wrote:
Sat Apr 14, 2018 7:11 pm
Artsdoctor wrote:
Sat Apr 14, 2018 6:54 pm
The bond in question may indeed have a coupon of 5%. It's a premium bond and if the yield to maturity is under 2%, the premium is going to be high. But that's another conversation altogether.
Your insight is appreciated!
I do not understand how the yield can go from 5% to 2%.
Kevin answered this question above, with an example example, in this same thread.

Iliketoridemybike
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sat Apr 14, 2018 8:49 pm

Mydanyale wrote:
Sat Apr 14, 2018 7:44 pm
hudson wrote:
Sat Apr 14, 2018 7:11 pm
Artsdoctor wrote:
Sat Apr 14, 2018 6:54 pm
The bond in question may indeed have a coupon of 5%. It's a premium bond and if the yield to maturity is under 2%, the premium is going to be high. But that's another conversation altogether.
Your insight is appreciated!
I do not understand how the yield can go from 5% to 2%.
Kevin answered this question above, with an example example, in this same thread.
His example may be a bit convoluted. To keep it simple: a 5% coupon on the original $1000 par value is $50 or 5% per year.
If you pay a premium of say $1100, a 5% coupon on $1100 is now only worth 4.5%. So the higher you pay for the bond, the lower your yield.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Sat Apr 14, 2018 9:15 pm

hudson wrote:
Sat Apr 14, 2018 7:11 pm
Artsdoctor wrote:
Sat Apr 14, 2018 6:54 pm
The bond in question may indeed have a coupon of 5%. It's a premium bond and if the yield to maturity is under 2%, the premium is going to be high. But that's another conversation altogether.
Your insight is appreciated!
I do not understand how the yield can go from 5% to 2%.
It's called bond premium. Let's say the bond has a coupon of 5%. However, since the year it was issued, interest rates have declined to 2%. Thus, the seller will ask for a premium, so that what you get will actually be 2% per annum of whatever you paid the seller.

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Kevin M
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sat Apr 14, 2018 9:15 pm

Artsdoctor wrote:
Sat Apr 14, 2018 1:38 pm
Kevin M wrote:
Sat Apr 14, 2018 12:47 pm
Artsdoctor wrote:
Fri Apr 13, 2018 5:37 pm
When you're buying a municipal bond, you're going to want a premium bond or at least a discount de minimis bond. If your discount bond is beyond de minimis, you're going to pay regular income tax on the gain (not just a capital gain), so it's best to avoid them.
I don't believe this is correct--at least without some further qualification.<snip>
You'll find this helpful (I hope):
<snip>
Yeah, there are many sources of information about this. Here's another one: https://www.aaii.com/journal/article/di ... tax-issues. Thanks for prompting me to take a closer look at this.

From my reading on this, it's more complicated than either of us is portraying. I stand by the comment about requiring additional qualification, as explained below, but from some quick reading, I think you are right about paying tax on market discount that doesn't meet the de minimis requirement. Seems pretty clear in IRS Pub 550:
Market discount on a tax-exempt bond is not tax-exempt. If you bought the bond after April 30, 1993, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as taxable interest. See Market Discount Bonds, later. If you do not make that choice, or if you bought the bond before May 1, 1993, any gain from market discount is taxable when you dispose of the bond.
https://taxmap.irs.gov/taxmap/pubs/p550 ... nk10009964

The qualification is in the definition of "market discount". From IRS Pub 1212:
Market discount.

A debt instrument generally is acquired with market discount if its stated redemption price at maturity is greater than its basis immediately after its acquisition. Market discount arises when a debt instrument purchased in the secondary market has decreased in value since its issue date, generally because of an increase in interest rates. An OID debt instrument has market discount if your adjusted basis in the debt instrument immediately after you acquired it (usually its purchase price) was less than the debt instrument's issue price plus the total OID that accrued before you acquired it. The market discount is the difference between the issue price plus accrued OID and your adjusted basis.
The last two sentences describe one thing I was talking about in my earlier reply. An OID bond can be bought at less than par and not have a market discount. For example, if a bond was originally sold at 95, and the total OID accrued before acquisition is 3, issue price + accrued OID = 98, so if I buy it at 98 or above, there is no market discount, and the market discount rules don't apply.

If I don't tell you anything except that I bought this bond at 99, I think most of us would say that I bought it at a discount, since it is a discount relative to par (100). But it may not have been bought at a "market discount" if it is an OID bond.

I had mainly paid attention to market discount on OID bonds, since until recently, the only bonds I bought at a discount were OID, and the prices I paid were more than the issue price plus total accrued OID. However, the bond I bought last Thursday, as posted in the OP, is not an OID bond (I had to look it up in EMMA to determine this).

I paid 99.667 after commission. I assume this is the price I use. So the market discount is 0.33%. Term to maturity is 1.8 years, and at first I thought the calculation would be 0.33%/1.8 = 0.19%, which is less than 0.25%. However, Pub 550 indicates that you use full years to maturity, so it looks like this bond does not meet the de minimis criterion.
Pub 550 wrote:Market discount is the amount of the stated redemption price of a bond at maturity that is more than your basis in the bond immediately after you acquire it. You treat market discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price of the bond multiplied by the number of full years to maturity (after you acquire the bond).
If all of this is correct, I'll pay ordinary income tax on about $50 for tax year 2020, since I bought 15 for 14,950.05 (not including accrued interest). Assuming my marginal tax rates still are 27% + 8%, as I estimate for 2018, I'll pay about $17.48 federal + state income tax. Not a big deal, but of course this reduces my TEY, so I'll have to refigure that.

Good stuff.

Kevin
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Iliketoridemybike
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sat Apr 14, 2018 9:27 pm

Kevin M wrote:
Sat Apr 14, 2018 9:15 pm
Artsdoctor wrote:
Sat Apr 14, 2018 1:38 pm
Kevin M wrote:
Sat Apr 14, 2018 12:47 pm
Artsdoctor wrote:
Fri Apr 13, 2018 5:37 pm
When you're buying a municipal bond, you're going to want a premium bond or at least a discount de minimis bond. If your discount bond is beyond de minimis, you're going to pay regular income tax on the gain (not just a capital gain), so it's best to avoid them.
I don't believe this is correct--at least without some further qualification.<snip>
You'll find this helpful (I hope):
<snip>
Yeah, there are many sources of information about this. Here's another one: https://www.aaii.com/journal/article/di ... tax-issues. Thanks for prompting me to take a closer look at this.

From my reading on this, it's more complicated than either of us is portraying. I stand by the comment about requiring additional qualification, as explained below, but from some quick reading, I think you are right about paying tax on market discount that doesn't meet the de minimis requirement. Seems pretty clear in IRS Pub 550:
Market discount on a tax-exempt bond is not tax-exempt. If you bought the bond after April 30, 1993, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as taxable interest. See Market Discount Bonds, later. If you do not make that choice, or if you bought the bond before May 1, 1993, any gain from market discount is taxable when you dispose of the bond.
https://taxmap.irs.gov/taxmap/pubs/p550 ... nk10009964

The qualification is in the definition of "market discount". From IRS Pub 1212:
Market discount.

A debt instrument generally is acquired with market discount if its stated redemption price at maturity is greater than its basis immediately after its acquisition. Market discount arises when a debt instrument purchased in the secondary market has decreased in value since its issue date, generally because of an increase in interest rates. An OID debt instrument has market discount if your adjusted basis in the debt instrument immediately after you acquired it (usually its purchase price) was less than the debt instrument's issue price plus the total OID that accrued before you acquired it. The market discount is the difference between the issue price plus accrued OID and your adjusted basis.
The last two sentences describe one thing I was talking about in my earlier reply. An OID bond can be bought at less than par and not have a market discount. For example, if a bond was originally sold at 95, and the total OID accrued before acquisition is 3, issue price + accrued OID = 98, so if I buy it at 98 or above, there is no market discount, and the market discount rules don't apply.

If I don't tell you anything except that I bought this bond at 99, I think most of us would say that I bought it at a discount, since it is a discount relative to par (100). But it may not have been bought at a "market discount" if it is an OID bond.

I had mainly paid attention to market discount on OID bonds, since until recently, the only bonds I bought at a discount were OID, and the prices I paid were more than the issue price plus total accrued OID. However, the bond I bought last Thursday, as posted in the OP, is not an OID bond (I had to look it up in EMMA to determine this).

I paid 99.667 after commission. I assume this is the price I use. So the market discount is 0.33%. Term to maturity is 1.8 years, and at first I thought the calculation would be 0.33%/1.8 = 0.19%, which is less than 0.25%. However, Pub 550 indicates that you use full years to maturity, so it looks like this bond does not meet the de minimis criterion.
Pub 550 wrote:Market discount is the amount of the stated redemption price of a bond at maturity that is more than your basis in the bond immediately after you acquire it. You treat market discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price of the bond multiplied by the number of full years to maturity (after you acquire the bond).
If all of this is correct, I'll pay ordinary income tax on about $50 for tax year 2020, since I bought 15 for 14,950.05 (not including accrued interest). Assuming my marginal tax rates still are 27% + 8%, as I estimate for 2018, I'll pay about $17.48 federal + state income tax. Not a big deal, but of course this reduces my TEY, so I'll have to refigure that.

Good stuff.

Kevin
Posts like this make individual bonds seems complicated when in reality they are not.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sat Apr 14, 2018 9:59 pm

Iliketoridemybike wrote:
Sat Apr 14, 2018 9:27 pm
Posts like this make individual bonds seems complicated when in reality they are not.
Please elaborate. Clearly the taxation of individual bonds can be a bit complicated. How can you simplify it for us?

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sat Apr 14, 2018 10:03 pm

Kevin M wrote:
Sat Apr 14, 2018 9:59 pm
Iliketoridemybike wrote:
Sat Apr 14, 2018 9:27 pm
Posts like this make individual bonds seems complicated when in reality they are not.
Please elaborate. Clearly the taxation of individual bonds can be a bit complicated. How can you simplify it for us?

Kevin
Turbo Tax download

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sat Apr 14, 2018 10:55 pm

Iliketoridemybike wrote:
Sat Apr 14, 2018 10:03 pm
Kevin M wrote:
Sat Apr 14, 2018 9:59 pm
Iliketoridemybike wrote:
Sat Apr 14, 2018 9:27 pm
Posts like this make individual bonds seems complicated when in reality they are not.
Please elaborate. Clearly the taxation of individual bonds can be a bit complicated. How can you simplify it for us?

Kevin
Turbo Tax download
Even if Turbo tax handled everything perfectly, it wouldn't help in making decisions about what to buy. For example, I didn't figure in the ordinary tax that will be due in figuring the TEY on the bond I discussed in the OP. Without understanding the taxation of market discount, which obviously I didn't, you can make bad decisions about whether or not a particular muni is a good deal.

Please tell me how TT will calculate my TEY for the bond discussed in the OP.

Also, TT or HRBlock (which I've switched to) require some knowledge about bonds if you're going to enter things correctly. For example, with HRBlock you need to check a box in the 1099-INT data entry screen indicating that the interest requires adjustment for discount or premium bonds, and even with that, I'm not sure it's going to handle the taxation of market discount on tax-exempt bonds correctly. Never done it before, so I'll find out next year.

You also have to check the same box to adjust for accrued interest for a taxable bond. Do you know how to enter the 1099-INT data when there is both accrued interest and a discount or premium (hint: there is a workaround to do this)?

Here's one I'll need the answer to next year. How do you most easily adjust for accrued interest and premium on an out of state muni bond in preparing a CA state income tax return? When preparing the federal return, you enter how much of the interest is exempt from CA state tax, and that is automatically carried to the state return as an addition to interest income. Do I figure out all the adjustments for bond premium and accrued interest myself, and adjust the amount I enter in preparing the federal return, in which case we're back to needing to understand all of this stuff. Or is there a more straightforward way to enter the adjustments when preparing the state return?

One more. Do you deduct accrued interest on out of state tax exempt bonds from the state tax return in the year the bond is bought or the year the interest is paid? I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sun Apr 15, 2018 9:34 am

Kevin M wrote:
Sat Apr 14, 2018 10:55 pm
Iliketoridemybike wrote:
Sat Apr 14, 2018 10:03 pm
Kevin M wrote:
Sat Apr 14, 2018 9:59 pm
Iliketoridemybike wrote:
Sat Apr 14, 2018 9:27 pm
Posts like this make individual bonds seems complicated when in reality they are not.
Please elaborate. Clearly the taxation of individual bonds can be a bit complicated. How can you simplify it for us?

Kevin
Turbo Tax download
Even if Turbo tax handled everything perfectly, it wouldn't help in making decisions about what to buy. For example, I didn't figure in the ordinary tax that will be due in figuring the TEY on the bond I discussed in the OP. Without understanding the taxation of market discount, which obviously I didn't, you can make bad decisions about whether or not a particular muni is a good deal.

Please tell me how TT will calculate my TEY for the bond discussed in the OP.

Also, TT or HRBlock (which I've switched to) require some knowledge about bonds if you're going to enter things correctly. For example, with HRBlock you need to check a box in the 1099-INT data entry screen indicating that the interest requires adjustment for discount or premium bonds, and even with that, I'm not sure it's going to handle the taxation of market discount on tax-exempt bonds correctly. Never done it before, so I'll find out next year.

You also have to check the same box to adjust for accrued interest for a taxable bond. Do you know how to enter the 1099-INT data when there is both accrued interest and a discount or premium (hint: there is a workaround to do this)?

Here's one I'll need the answer to next year. How do you most easily adjust for accrued interest and premium on an out of state muni bond in preparing a CA state income tax return? When preparing the federal return, you enter how much of the interest is exempt from CA state tax, and that is automatically carried to the state return as an addition to interest income. Do I figure out all the adjustments for bond premium and accrued interest myself, and adjust the amount I enter in preparing the federal return, in which case we're back to needing to understand all of this stuff. Or is there a more straightforward way to enter the adjustments when preparing the state return?

One more. Do you deduct accrued interest on out of state tax exempt bonds from the state tax return in the year the bond is bought or the year the interest is paid? I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.

Kevin
I’ve never had an issue using TurboTax. All the data you need is reported to you and available for download including premiums paid. Fidelity even breaks it out for you on a YTD basis so you should know that going into tax time.
Last edited by Iliketoridemybike on Sun Apr 15, 2018 9:44 am, edited 1 time in total.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sun Apr 15, 2018 9:41 am

A lot of people buy and manage individual bonds and create bond ladders. Many do it well into their senior years. It isn’t rocket science. There are tools to help you setup what kind of cash flow you want, pick the duration and make sure you don’t reach into too many low credit offerings to get yield. I enjoy it. It is far better than watching my nest egg go down in an intermediate bond fund.
Once rates stabilize, I am not opposed to using a fund again, but as rates rise, I like a ladder. Though there are many on here that will disagree with that approach. I know, they have told me already. :D

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sun Apr 15, 2018 11:41 am

Kevin M wrote:
Sat Apr 14, 2018 9:15 pm
If all of this is correct, I'll pay ordinary income tax on about $50 for tax year 2020, since I bought 15 for 14,950.05 (not including accrued interest). Assuming my marginal tax rates still are 27% + 8%, as I estimate for 2018, I'll pay about $17.48 federal + state income tax. Not a big deal, but of course this reduces my TEY, so I'll have to refigure that.
So here's how I'm estimating my TEY factoring in full taxation of the market discount.

I will receive four coupons of $150 each, for total of $600 in income return. Subtracting accrued interest of 62.50, my net income return is 537.50. This is federal tax exempt (but not state tax exempt).

The market discount portion of the return is 49.95, and this is fully taxed at federal and state marginal rates of 27% and 8%.

So total dollar return is 587.45, 91.50% of which is federally tax-exempt coupon interest and 8.50% of which is fully taxable. I had already calculated the yield of 2.190% and the TEY of 3.099% assuming fully federal tax exempt. So 91.50% is TEY of 3.099% and 8.50% is TEY of 2.190% (TEY for fully taxable is just the yield), and the weighted TEY is 3.022%. It's probably a little higher than this, because the tax on market discount will not be paid until 2021, the year after the bond matures, so the present value of the tax cash flow is less than if it were paid in semi-annual or annual installments.

Make sense?

TEY of 3.022% is about 8 bps less than originally figured TEY of 3.099%, but I still would have bought this bond if I had figured in the tax on market discount, as it's still a very good yield compared to the 2.65% or so you can earn on a 2-year CD or a 2-year Treasury in taxable at my tax rates. The higher TEY is compensation for minimal credit risk and some liquidity risk compared to Treasuries (but probably not compared to CDs), but the latter is of no concern to me.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sun Apr 15, 2018 12:29 pm

hudson wrote:
Sat Apr 14, 2018 6:25 pm
I got a guest account at Fidelity for 30 days...easy.
The first NC muni I came to is here...you've got to have a Fidelity account or a guest account to follow this link I suspect...

https://fixedincome.fidelity.com/ftgw/f ... renceName=

The site wouldn't give me the CUSIP....so I couldn't ask EMMA.
How would you evaluate this bond....it looks like it's paying 5%.

Many thanks!
I clicked your link, and am taken to the Fidelity bond overview page for the bond. I happened to be logged onto Fidelity in another tab, and I think it used my credentials to let me access the page. The CUSIP, 65825PCA6, is the first thing you see in the Details section near the top left of the page.

You get a lot of the info you need from this page, including coupon rate, maturity date, rating, and call protection, to name a few. Much of what you need to calculate the yield is available, but you also need price, which is not displayed here. Typically you'll see the yield wherever you see the price. I note that the rating is AA1/AA+, which are the highest AA ratings, and just below AAA, so credit risk probably is very low, although the ratings are from 2016.

Going to the Fidelity bond search screen, I enter the CUSIP, and see that as of market close on Friday, there were 10 available at price of 103.498 and yield of 1.591%. This is before commission. When I enter the necessary info into my spreadsheet to calculate yield, I get 4.222%. Since this is much higher than what Fidelity shows, the yield displayed by Fidelity must be yield to worst, meaning the yield to the first call date (even though same yield is displayed for yield to maturity).

Back in the bond overview page for this bond I see that it is not call protected, and can view the call schedule by clicking the View Schedule link in the first row under Redemptive Features. I see call at 100 on 5/1/2019. If I change the maturity date in my spreadsheet from the stated maturity of 5/1/2023 to the call date of 5/1/2019, I also calculate the yield as 1.591%. After commission the yield is 1.496%

So what you really are looking at is a 1-year bond with a yield of 1.496%. To calculate your TEY I'd need to know your marginal federal and state tax rates, and whether or not you will itemize and deduct state income tax on your federal return. For me, as a non-NC resident, TEY is 2.118%. Considering that I could buy a Treasury maturing on about the same date with a yield of 2.114% (for quantity 10 based on Friday's closing quotes or whatever it is that Fidelity currently displays), which for me is a TEY of 2.37%, I would prefer a 1-year Treasury to this muni bond.

The TEY of the muni probably will be higher for you as a NC resident. If this were a CA bond, the TEY for me would be 2.302%, so still not as high as my TEY for 1-year Treasury, so I still would prefer the Treasury.

You can get to EMMA directly from the Fidelity bond overview page by clicking a number of different links on the page, but an obvious one is the YES link to the right of EMMA, also in the Details section. Clicking this opens up EMMA for this bond, and defaults to the Continuing Disclosure page. Tons of documents, and nothing I probably would read. You can look at the trade activity here, but you also can view recent trade activity directly from the Fidelity search results screen.

Kevin
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Mydanyale
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mydanyale » Sun Apr 15, 2018 1:21 pm

Kevin M wrote:
Sun Apr 15, 2018 12:29 pm
hudson wrote:
Sat Apr 14, 2018 6:25 pm
I got a guest account at Fidelity for 30 days...easy.
The first NC muni I came to is here...you've got to have a Fidelity account or a guest account to follow this link I suspect...

https://fixedincome.fidelity.com/ftgw/f ... renceName=

The site wouldn't give me the CUSIP....so I couldn't ask EMMA.
How would you evaluate this bond....it looks like it's paying 5%.

Many thanks!
I clicked your link, and am taken to the Fidelity bond overview page for the bond. I happened to be logged onto Fidelity in another tab, and I think it used my credentials to let me access the page. The CUSIP, 65825PCA6, is the first thing you see in the Details section near the top left of the page.

You get a lot of the info you need from this page, including coupon rate, maturity date, rating, and call protection, to name a few. Much of what you need to calculate the yield is available, but you also need price, which is not displayed here. Typically you'll see the yield wherever you see the price. I note that the rating is AA1/AA+, which are the highest AA ratings, and just below AAA, so credit risk probably is very low, although the ratings are from 2016.

Going to the Fidelity bond search screen, I enter the CUSIP, and see that as of market close on Friday, there were 10 available at price of 103.498 and yield of 1.591%. This is before commission. When I enter the necessary info into my spreadsheet to calculate yield, I get 4.222%. Since this is much higher than what Fidelity shows, the yield displayed by Fidelity must be yield to worst, meaning the yield to the first call date (even though same yield is displayed for yield to maturity).

Back in the bond overview page for this bond I see that it is not call protected, and can view the call schedule by clicking the View Schedule link in the first row under Redemptive Features. I see call at 100 on 5/1/2019. If I change the maturity date in my spreadsheet from the stated maturity of 5/1/2023 to the call date of 5/1/2019, I also calculate the yield as 1.591%. After commission the yield is 1.496%

So what you really are looking at is a 1-year bond with a yield of 1.496%. To calculate your TEY I'd need to know your marginal federal and state tax rates, and whether or not you will itemize and deduct state income tax on your federal return. For me, as a non-NC resident, TEY is 2.118%. Considering that I could buy a Treasury maturing on about the same date with a yield of 2.114% (for quantity 10 based on Friday's closing quotes or whatever it is that Fidelity currently displays), which for me is a TEY of 2.37%, I would prefer a 1-year Treasury to this muni bond.

The TEY of the muni probably will be higher for you as a NC resident. If this were a CA bond, the TEY for me would be 2.302%, so still not as high as my TEY for 1-year Treasury, so I still would prefer the Treasury.

You can get to EMMA directly from the Fidelity bond overview page by clicking a number of different links on the page, but an obvious one is the YES link to the right of EMMA, also in the Details section. Clicking this opens up EMMA for this bond, and defaults to the Continuing Disclosure page. Tons of documents, and nothing I probably would read. You can look at the trade activity here, but you also can view recent trade activity directly from the Fidelity search results screen.

Kevin
Hi Kevin,
I believe there is a relative disadvantage in choosing treasuries vs municipal with all else equal or similar, which is that it moves your federal marginal tax rate up. This is something to consider when you are near your tax bracket limits. And then there is the NIIT.
On another note, I subscribed to your blog.
Thanks for sharing your experience here.

hudson
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by hudson » Sun Apr 15, 2018 1:23 pm

Wow! thanks for the details! I couldn't get back into my guest account so I think I'll just sign up for a brokerage account and re-read all of your hints a few times and come back and ask a few more questions. I need to get up to speed before my Penfed CDs run out...thanks again for that.

Mydanyale
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mydanyale » Sun Apr 15, 2018 1:29 pm

Iliketoridemybike wrote:
Sun Apr 15, 2018 9:41 am
A lot of people buy and manage individual bonds and create bond ladders. Many do it well into their senior years. It isn’t rocket science. There are tools to help you setup what kind of cash flow you want, pick the duration and make sure you don’t reach into too many low credit offerings to get yield. I enjoy it. It is far better than watching my nest egg go down in an intermediate bond fund.
Once rates stabilize, I am not opposed to using a fund again, but as rates rise, I like a ladder. Though there are many on here that will disagree with that approach. I know, they have told me already. :D
Hi,
Would you mind sharing some of your favorite tools for selecting/purchasing your bond holdings?
Btw, I agree with you that individual bond holdings are overall safer than bond funds when higher interest rates are expected, despite the lack of diversification. That is precisely the reason I am trying to learn about it.

gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Sun Apr 15, 2018 2:31 pm

Kevin M wrote:
Sat Apr 14, 2018 10:55 pm

One more. Do you deduct accrued interest on out of state tax exempt bonds from the state tax return in the year the bond is bought or the year the interest is paid? I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.
Kevin
I don't know about CA, but I tried researching it for my federal return, but never found a definitive answer. However, what I discovered is that TurboTax won't let you enter a bond premium that is greater than the interest reported on the 1099 for that bond, which will be zero in a year where no coupon is paid. So I decided to wait until I had a coupon, even though it may not be right technically. Also, I would look to see what was reported on the 1099 for the year with no coupon. If the CPA took the bond premium, but its not there on the 1099, you risk getting a matching notice, unless you append a short cover note, which i hate to do personally. Also, the amount he entered was I hope pretty small for a bond purchased in December, as you can't amortize for the interest that has accruing in the months before you owned the bond.

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Kevin M
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Sun Apr 15, 2018 3:28 pm

gmaynardkrebs wrote:
Sun Apr 15, 2018 2:31 pm
Kevin M wrote:
Sat Apr 14, 2018 10:55 pm

One more. Do you deduct accrued interest on out of state tax exempt bonds from the state tax return in the year the bond is bought or the year the interest is paid? I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.
Kevin
I don't know about CA, but I tried researching it for my federal return, but never found a definitive answer. However, what I discovered is that TurboTax won't let you enter a bond premium that is greater than the interest reported on the 1099 for that bond, which will be zero in a year where no coupon is paid. So I decided to wait until I had a coupon, even though it may not be right technically. Also, I would look to see what was reported on the 1099 for the year with no coupon. If the CPA took the bond premium, but its not there on the 1099, you risk getting a matching notice, unless you append a short cover note, which i hate to do personally. Also, the amount he entered was I hope pretty small for a bond purchased in December, as you can't amortize for the interest that has accruing in the months before you owned the bond.
Thanks for the reply. Note that I am talking about accrued interest, not premium amortization. Since no coupon payments were received in 2017, I will deal with the premiums starting in tax year 2018.

Fidelity and Vanguard report accrued interest for securities purchased in 2017 in a supplementary form in their 2017 1099-Consolidated packages. That's where my CPA picked it up from. It's not reported on 1099-INT.

In HRBlock, and I belive TT too, for accrued interest you can check the box "interest item requires an adjustment (uncommon)". Doing a dummy 1099-INT entry for a non-CA bond, I enter $1,000 of tax-exempt interest. There is a box to enter bond premium on tax-exempt bond, but that is only for covered securities (since I haven't received a 1099-INT yet, I don't know if this will be reported on 1099-INT). I'll enter 100 here, then check the box to adjust the interest.

Next screen is amount exempt from state tax, and I'll enter 0 here, since I'm assuming a non-CA bond.

Next is the adjustment screen. I check "Bought or sold this bond between interest payments". The next screen is "Accrued interest adjustment". I'll enter 50 here.

At this point, I see 855 of tax-exempt interest on line 8b of form 1040. Don't see how that was arrived at. Can anyone explain it? I cannot find where HRB is calculating this.

On Form CA 540, the CA adjustments form, I see an addition of 950 for taxable interest. So the accrued interest was subtracted from the 1,000, but no premium amortization was subtracted.

As you say, you must enter a positive number for interest in the 1099-INT, so could not use interview mode to do what my CPA did, and have the accrued interest subtracted on the CA return. I would have just reported it for 2018, but now I'll have to keep track of for which bonds my CPA already deducted it for 2017.

If the 1099-INT reduces the interest reported in box 8 (tax exempt interest) by the amount of amortied bond premium, then this should be handled. However, the broker also has the option to report the amortized premium in box 11 and not reduce the amount reported in box 8. In this case, HRBlock indicates to check the box for adjustment. However, in the adjustments screen, you can only select one item, so either accrued interest or bond premium amortization. The workaround people have posted for this is to split the tax-exempt income into two 1099-INT forms in the tax software, and use one for accrued interest and one for bond premium.

Using this approach I enter 500 TE interest and the accrued interest of 50 in one 1099-INT, and 500 of TE interest and 100 premium amortization in the other 1099-INT. 1040 line 8b now shows 770. Still don't see how this is calculated. Schedule CA 540 now shows 850 of additions, so both accrued interest and bond premium amortization are subtracted from the 1,000 of TE interest, so this is correct.

OK, so I think I'm prepared to handle this next tax season, but still don't understand how HRB is calculating the amount reported on line 8b.

Kevin
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gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Sun Apr 15, 2018 3:41 pm

Kevin M wrote:
Sun Apr 15, 2018 3:28 pm
gmaynardkrebs wrote:
Sun Apr 15, 2018 2:31 pm
Kevin M wrote:
Sat Apr 14, 2018 10:55 pm

One more. Do you deduct accrued interest on out of state tax exempt bonds from the state tax return in the year the bond is bought or the year the interest is paid? I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.
Kevin
I don't know about CA, but I tried researching it for my federal return, but never found a definitive answer. However, what I discovered is that TurboTax won't let you enter a bond premium that is greater than the interest reported on the 1099 for that bond, which will be zero in a year where no coupon is paid. So I decided to wait until I had a coupon, even though it may not be right technically. Also, I would look to see what was reported on the 1099 for the year with no coupon. If the CPA took the bond premium, but its not there on the 1099, you risk getting a matching notice, unless you append a short cover note, which i hate to do personally. Also, the amount he entered was I hope pretty small for a bond purchased in December, as you can't amortize for the interest that has accruing in the months before you owned the bond.
Thanks for the reply. Note that I am talking about accrued interest, not premium amortization. Since no coupon payments were received in 2017, I will deal with the premiums starting in tax year 2018.

Fidelity and Vanguard report accrued interest for securities purchased in 2017 in a supplementary form in their 2017 1099-Consolidated packages. That's where my CPA picked it up from. It's not reported on 1099-INT.

In HRBlock, and I belive TT too, for accrued interest you can check the box "interest item requires an adjustment (uncommon)". Doing a dummy 1099-INT entry for a non-CA bond, I enter $1,000 of tax-exempt interest. There is a box to enter bond premium on tax-exempt bond, but that is only for covered securities (since I haven't received a 1099-INT yet, I don't know if this will be reported on 1099-INT). I'll enter 100 here, then check the box to adjust the interest.

Next screen is amount exempt from state tax, and I'll enter 0 here, since I'm assuming a non-CA bond.

Next is the adjustment screen. I check "Bought or sold this bond between interest payments". The next screen is "Accrued interest adjustment". I'll enter 50 here.

At this point, I see 855 of tax-exempt interest on line 8b of form 1040. Don't see how that was arrived at. Can anyone explain it? I cannot find where HRB is calculating this.

On Form CA 540, the CA adjustments form, I see an addition of 950 for taxable interest. So the accrued interest was subtracted from the 1,000, but no premium amortization was subtracted.

As you say, you must enter a positive number for interest in the 1099-INT, so could not use interview mode to do what my CPA did, and have the accrued interest subtracted on the CA return. I would have just reported it for 2018, but now I'll have to keep track of for which bonds my CPA already deducted it for 2017.

If the 1099-INT reduces the interest reported in box 8 (tax exempt interest) by the amount of amortied bond premium, then this should be handled. However, the broker also has the option to report the amortized premium in box 11 and not reduce the amount reported in box 8. In this case, HRBlock indicates to check the box for adjustment. However, in the adjustments screen, you can only select one item, so either accrued interest or bond premium amortization. The workaround people have posted for this is to split the tax-exempt income into two 1099-INT forms in the tax software, and use one for accrued interest and one for bond premium.

Using this approach I enter 500 TE interest and the accrued interest of 50 in one 1099-INT, and 500 of TE interest and 100 premium amortization in the other 1099-INT. 1040 line 8b now shows 770. Still don't see how this is calculated. Schedule CA 540 now shows 850 of additions, so both accrued interest and bond premium amortization are subtracted from the 1,000 of TE interest, so this is correct.

OK, so I think I'm prepared to handle this next tax season, but still don't understand how HRB is calculating the amount reported on line 8b.

Kevin
Thanks, I did misread. This is very helpful. I must say, however, that some people may find owning individual bonds a headache at tax time. Maybe that's why the returns on purchasing individual bonds are a little better -- the hassle premium.

ofckrupke
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Sun Apr 15, 2018 4:05 pm

Kevin M wrote:
Sun Apr 15, 2018 3:28 pm
At this point, I see 855 of tax-exempt interest on line 8b of form 1040. Don't see how that was arrived at. Can anyone explain it? I cannot find where HRB is calculating this.
Is this on an otherwise live return? Your exempt interest dividends from mutual muni funds (you own some vanguard national and CA TE I believe) will contribute to the tally on form 1040 line 8b as well.

NEver mind....

ofckrupke
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Sun Apr 15, 2018 4:47 pm

Kevin M wrote:
Sat Apr 14, 2018 10:55 pm
I bought some out of state munis in December, but no out of state muni interest was paid in 2017. My CPA entered the accrued interest as a negative number in the CA adjustments additions column (I used a CPA for 2017 taxes for a specific, non-recurring reason, and almost certainly will go back to doing my own taxes for 2018). I would never have thought of doing that, and am still not sure it's correct.
Because the instructions for 540CA say not to enter a negative number in an individual column B or C cell unless otherwise instructed, and I don't see an instruction specific to this situation, my inclination would be to treat this accrued interest cost instead as a positive number under form 540CA line 41 - that is, as a miscellaneous expense, not elsewhere accountable, associated with an investment that generates income taxed in CA but not federally. That would certainly feel better were 1040/540CA line 8b to read zero. But IANACPA.

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Artsdoctor
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Artsdoctor » Sun Apr 15, 2018 4:53 pm

Kevin,

You're getting closer to appreciating the complexities of a discount bond and its taxation.

I am aware of the "discount of a discount" phenomenon (paying a discount on a bond that was sold at a discount). This is why I never buy municipal zeroes; the hassle factor is just too great and I don't want to calculate those numbers (and I don't want to pay my accountant to do it either).

Presumably, most investors buying munis are tax-sensitive (i.e., their marginal tax brackets are high). These investors, as a rule, would be better off avoiding discount bonds because of the tax on that discount, as I mentioned. It is far, far easier to just buy a premium bond and amortize. If your marginal tax rate on interest income is high, and mine is close to 50%, then you're not going to want to be bothered at all with paying tax on your munis.

For what it's worth, Turbo Tax will take care of the accrued interest and premium amortization, although you really have to play around and understand the Schedule B component of TT. Once you see what they want, it's easy; however, it's not as obvious as it should be, in my opinion. If you need more help with the way TT handles in-state and out-of-state amortization, let me know.

I don't know how to deal with discount bonds on Turbo Tax since I've avoided them.

If all of this seems complicated, it is. I'm skeptical that people with a large number of munis think that this is easy, unless they just give the paperwork to the accountant--or don't understand the complexities in the first place. I have had individual munis for many years and once you set up your paperwork, it's actually not too bad; however, I have never found a way to just put things on autopilot, and I rarely buy munis nowadays because I just don't want the hassle. To make matters worse, if you don't understand amortization, you put yourself at risk for using a brokerage's numbers--which may not be accurate (Vanguard is not as adept at Fidelity when it comes to amortization, based on my personal experience.)

gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Sun Apr 15, 2018 4:55 pm

728. Bond Transaction Between Interest Dates. When a bond is sold between
interest dates, part of the sales price represents the interest earned up to the date of sale.
The seller reports that portion as interest income in the year of the sale (Reg.
§1.61-7(d)).67 Because the buyer has paid for the accrued interest as part of the sales
price, the interest is a return of capital if it is later paid, which reduces his or her basis in
the bond, rather than taxable interest income, except to the extent it exceeds the
amount paid the seller (Reg. § 1.61-7(c)). This interest adjustment has no effect on the
cost of the bond and apparently has no connection with the adjustment for amortizable
bond premium (¶1967).
This from the CCH tax quide. I'm not sure its on point, nor do I get the part about except to the extent it exceeds the amount paid the seller.

Iliketoridemybike
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Iliketoridemybike » Sun Apr 15, 2018 6:47 pm

Mydanyale wrote:
Sun Apr 15, 2018 1:29 pm
Iliketoridemybike wrote:
Sun Apr 15, 2018 9:41 am
A lot of people buy and manage individual bonds and create bond ladders. Many do it well into their senior years. It isn’t rocket science. There are tools to help you setup what kind of cash flow you want, pick the duration and make sure you don’t reach into too many low credit offerings to get yield. I enjoy it. It is far better than watching my nest egg go down in an intermediate bond fund.
Once rates stabilize, I am not opposed to using a fund again, but as rates rise, I like a ladder. Though there are many on here that will disagree with that approach. I know, they have told me already. :D
Hi,
Would you mind sharing some of your favorite tools for selecting/purchasing your bond holdings?
Btw, I agree with you that individual bond holdings are overall safer than bond funds when higher interest rates are expected, despite the lack of diversification. That is precisely the reason I am trying to learn about it.
My favorite tools....
https://www.fidelity.com/fixed-income-b ... s/overview

aqan
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by aqan » Sun Apr 15, 2018 7:18 pm

gmaynardkrebs wrote:
Sat Apr 14, 2018 1:17 pm
aqan wrote:
Sat Apr 14, 2018 9:30 am
Kevin M wrote:
Thu Apr 12, 2018 4:38 pm

For me, at 27% federal and 8% state marginal tax rates, not itemizing, this is a taxable-equivalent yield (TEY) of 3.099%. This is compared to the 2.65% yield on the best new-issue 2-year brokered CDs, which is an example of what I've been buying in tax-advantaged (typically getting slightly higher yield on secondary market). Another point of comparison is 2-year Treasury at 2.34%, which for me is a TEY of 2.63% (so about the same as a 2-year CD in taxable).
Does it make sense for someone itemizes and pays AMT to invest in munis? Someone told me that you lose tax advantage when you pay AMT.
Under the new tax law, unless your household income is in the $1M range, the AMT is gone -- at last.
Nice! thanks for clarification.

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Kevin M
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Mon Apr 16, 2018 3:39 pm

Artsdoctor wrote:
Sun Apr 15, 2018 4:53 pm
Kevin,

You're getting closer to appreciating the complexities of a discount bond and its taxation.
Why just getting closer? I think I completely understand it now. I only own one bond for which this is an issue, and I understand how to deal with it now.
I am aware of the "discount of a discount" phenomenon (paying a discount on a bond that was sold at a discount). This is why I never buy municipal zeroes; the hassle factor is just too great and I don't want to calculate those numbers (and I don't want to pay my accountant to do it either).
I didn't find it difficult, although it did take a few minutes looking at the offering document to determine that I was paying more than OID plus accrued OID, so no "market" discount. As I said, for the first one, I called Fidelity to verify, and he did so in about a minute.
Presumably, most investors buying munis are tax-sensitive (i.e., their marginal tax brackets are high). These investors, as a rule, would be better off avoiding discount bonds because of the tax on that discount, as I mentioned. It is far, far easier to just buy a premium bond and amortize. If your marginal tax rate on interest income is high, and mine is close to 50%, then you're not going to want to be bothered at all with paying tax on your munis.
I certainly can understand that it's easier to just avoid discount bonds, but I'll probably still consider them, although they have been by far the exception for bonds that meet my search criteria.
For what it's worth, Turbo Tax will take care of the accrued interest and premium amortization, although you really have to play around and understand the Schedule B component of TT. Once you see what they want, it's easy; however, it's not as obvious as it should be, in my opinion. If you need more help with the way TT handles in-state and out-of-state amortization, let me know.
I've been using HRBlock for last few years, but from what I've read here, I think they handle things similarly. I think I've figured it out for HRB, but thanks for the offer, and I may get back to you if I run into any more confusion. I'm pretty sure I've seen mention of the dual 1099-INT workaround for TurboTax for handling both premium and accrued interest when the 1099-INT does not reduce the amount in box 8 for the amortized premium.
If all of this seems complicated, it is. I'm skeptical that people with a large number of munis think that this is easy, unless they just give the paperwork to the accountant--or don't understand the complexities in the first place. I have had individual munis for many years and once you set up your paperwork, it's actually not too bad; however, I have never found a way to just put things on autopilot, and I rarely buy munis nowadays because I just don't want the hassle. To make matters worse, if you don't understand amortization, you put yourself at risk for using a brokerage's numbers--which may not be accurate (Vanguard is not as adept at Fidelity when it comes to amortization, based on my personal experience.)
I have spreadsheets that calculate the amortized premiums by coupon date, and I will be using those to verify whatever the brokers report. Agree that this is not for someone who is faint of heart with respect to understanding all of the tax-reporting implications, despite the one poster who seems to think that TurboTax will handle everything with no need for understanding what you're doing.

I would use a muni bond fund if there was one met my needs and provided similar risk-adjusted return for this particular part of my portfolio, but there isn't one that does.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Wed Apr 18, 2018 5:33 pm

Artsdoctor wrote:
Sat Apr 14, 2018 5:54 pm
^ Kevin: I think there's a misunderstanding. I was referring to the State of Illinois General Obligation bonds; the state has a BBB- credit rating. You're not going to find a State of Illinois General Obligation bond with an AA rating.
Not a misunderstanding--just pointing out that I'm not buying any BBB- bonds from IL. Your phrasing was " Even the state's general obligation bonds are rated BBB-", the use of "even" coming across to me as that's some sort of baseline. Why even bring up BBB- state GO bonds if that's not what I'm buying?
Having an IL GO bond in a muni fund which holds thousands of bonds is nearly insignificant.
Of course, but that was just one point in my argument that it's not necessarily irrational to hold some IL bonds, and that I'm not taking any particularly large risk by holding some. Again, IL bonds comprise less than 12% of my munis, 41% of those are AAA, and 80% of the AA bonds mature in a year or less. Also consider that this sub-portfolio is less than 15% of my total portfolio value.
It's when you're holding the individual muni alone that creates significant risk.
Alone? It's not alone--it's part of a fairly diversified ladder. Of course not as diversified as a fund, but no fund gives me the attributes I'm looking for with this particular sub-portfolio. My portfolio spreadsheet is not up to date, but according to it, my largest IL holding is less than 0.4% of my portfolio value, and I think it's actually less than that. I would not call the risk I'm taking significant, considering all of the facts I've presented.
Remember that ratings are assigned when the bond is issued. There are many bonds which are never re-evaluated. Consequently, you may be thinking you're buying an AA-rated bond but if that rating was assigned in 2001, you need to be aware of that. Obviously, bonds from big issuers that are more frequently traded are re-assessed more frequently; EMMA will give you all of that information.
This is a good point, and one I've been keeping in mind. But I also consider the historical default rates for the relevant maturities and ratings of the bonds I'm buying. They are 0.00% (for 1970-2011). If that's not good enough, we can also look at the historical one-year rating downgrade rates, which are very low. So basically an AA bond has to surprise everyone and go straight to default, or it has to go through multiple downgrades over 1-3 years before it defaults, the combined probability of which is extremely low based on historical results.

Of course we might see some surprises relative to historical results, but that's always the case with all of our investing decisions.

Regarding this point and the IL bonds, I was pleasantly surprised to receive an alert that the rating of one of my IL bonds had been upgraded! CUSIP 214831MD8, which was rated AA by S&P when I bought it on 1/12/2018 was upgraded to AA+ on 2/23/2018. https://emma.msrb.org/SecurityView/Secu ... 92220C7341 . Pretty cool, huh?
I can't think of a state with more financial woes than IL at the current time. Christine Benz (Morningstar, based in Chicago) jokingly said she wouldn't go near an IL bond with a 10-foot pole and Larry was even trying to get his daughter to move out at one point!
Quips like this do little to advance the discussion on a rational basis. I think you're painting IL bonds with too broad of a brush. As I believe you pointed out earlier, municipalities within a state, and even within a county, can vary widely in their ratings. S&P certainly is aware of IL state woes, yet they upgraded the rating of one of my IL bonds to one rating below AAA, and have not downgraded any of them.

I think this dialog is good, in that it highlights the importance of due diligence when buying individual munis. It is much more complicated than buying Treasuries or FDIC-insured CDs, which have essentially no credit risk. I would not recommend it to anyone who doesn't have the time and interest to really dig into it, and who doesn't understand the risks. I appreciate the challenge to motivate me to carefully work through my reasoning about all of it.

Kevin
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Artsdoctor
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Artsdoctor » Wed Apr 18, 2018 7:50 pm

We are really dancing on the head of a pin here. I really have no doubt that your investments will be safe. We are having an extremely refined conversation about credit risk and taxation, and I appreciate the back-and-forth. For whatever reason, I have really enjoyed learning about fixed income investments over the past 10-15 years and, in particular, have integrated munis and TIPS into a large chunk of my investment portfolio.

The discomfort I have discussing individual munis in a general forum is that I suspect that the majority of individual investors may be misunderstanding their investments. It takes work to buy individual munis correctly, at least in my opinion. Many investors don't understand premium versus discount bonds, taxation, YTM versus YTC, credit risk, spreads, total costs, etc. You are a highly educated investor and I know that people respect you. When you say that you've found decent individual munis with a good return, I do not doubt that, and I suspect that many people will try to find those investments and dabble. However, I suspect that you assume that most people have the same sophistication that you do; this is probably the only significant disagreement we'll have.

Two-year munis can be a great buy. It's how you get there that counts. As you point out, they are not FDIC-insured CDs. Go back and re-read the thread. You will find that there are comments that are very representative of misunderstandings surrounding munis (and bonds as a whole). My only piece of unsolicited advice would be that if you're going to recommend individual munis, that you also give people the tools to pick and choose wisely.

gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu Apr 19, 2018 9:29 am

Artsdoctor wrote:
Wed Apr 18, 2018 7:50 pm
We are really dancing on the head of a pin here. I really have no doubt that your investments will be safe. We are having an extremely refined conversation about credit risk and taxation, and I appreciate the back-and-forth. For whatever reason, I have really enjoyed learning about fixed income investments over the past 10-15 years and, in particular, have integrated munis and TIPS into a large chunk of my investment portfolio.

The discomfort I have discussing individual munis in a general forum is that I suspect that the majority of individual investors may be misunderstanding their investments. It takes work to buy individual munis correctly, at least in my opinion. Many investors don't understand premium versus discount bonds, taxation, YTM versus YTC, credit risk, spreads, total costs, etc. You are a highly educated investor and I know that people respect you. When you say that you've found decent individual munis with a good return, I do not doubt that, and I suspect that many people will try to find those investments and dabble. However, I suspect that you assume that most people have the same sophistication that you do; this is probably the only significant disagreement we'll have.

Two-year munis can be a great buy. It's how you get there that counts. As you point out, they are not FDIC-insured CDs. Go back and re-read the thread. You will find that there are comments that are very representative of misunderstandings surrounding munis (and bonds as a whole). My only piece of unsolicited advice would be that if you're going to recommend individual munis, that you also give people the tools to pick and choose wisely.
I'd love to be able to do what Kevin does, because I think there's some free lunches out there in muni-land for expert gents like Kevin to snatch up. However, I'm scared s**tless. And that's the case even though I feel I have a well above average understanding of bond basics, such as premium, discount, OID, accrued interest, and taxation, gained through arduous and extremely unpleasant time spent fooling with both TurboTax and H&R Block, trying to get my taxes right. There are more pitfalls than I feel I will ever be able to predict or understand.The muni market is still quite opaque. Remember the auction rate securities mess in 2009? How many muni investors had any idea the extent to which the big banks and brokerages had been propping up a wide swath of muni prices to protect what amounted to a legalized swindle of Mom & Pop holders of ARS securities. God knows what else is out there -- ratings fraud, accounting fraud, illegal corruption, legalized corruption (which is worse)? As I said, if were Kevin, or Larry Swedroe, I'd be doing it. But I ain't them, and I know it.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Thu Apr 19, 2018 4:05 pm

Thanks for the comments Artdoctor. I agree with most of what you said in most recent reply. Here are some quibbles.
Artsdoctor wrote:
Wed Apr 18, 2018 7:50 pm
However, I suspect that you assume that most people have the same sophistication that you do; this is probably the only significant disagreement we'll have.
Absolutely not! I have much experience trying to help family and friends with investing, and have come to the conclusion that target date funds probably are best for most people in retirement accounts, and at most something like a 3-fund portfolio across taxable and tax-advantaged accounts. This is especially true for accumulators with relatively large stock allocations, or for anyone who values simplicity and just doesn't want to delve to deeply into the intricacies of more involved strategies, like using CDs and individual Treasuries for part of their fixed income.

I've already said that buying individual munis requires much more due diligence than buying CDs or individual Treasuries, and even the latter is too much complication for most people. In this thread I'm simply sharing a new adventure I've embarked on--one that I feel is appropriate for this part of my portfolio, but that requires a lot of study and work to do effectively. In addition to sharing what I've learned, I get to learn more, like the market discount taxation you motivated me to dig into and make sure I understood.
My only piece of unsolicited advice would be that if you're going to recommend individual munis, that you also give people the tools to pick and choose wisely.
I think I've said before that I'm not recommending it, just sharing what I'm doing for those who are interested. Hopefully for those who have the time, interest, and skills to look into buying munis, the information those of us who've done it have shared in this thread will be useful.

Speaking of tools, I mentioned in a similar CD thread I started that I've come up with a new approach to quickly evaluate a large number of securities to determine which ones are offering the best yield premiums for extending maturity. This has been working really well compared the the approach I was using before, evaluating one CD at a time. Today I used this approach to evaluate 125 CDs that met my search criteria, and was able to quickly identify and buy a few that were particularly good deals.

I've adapted the approach to evaluating munis, and it also is much more effective. No time to go into details right now, but, basically I download the search results from Fidelity for munis that meet my criteria, and load the results into a spreadsheet. I add columns to calculate yield (to check against the yield Fidelity displays), TEY, and bps per year of TEY for extending maturity. I can then quickly scan the bps/year column (or add a column that shows only bps/year that exceed a specified threshhold, say 25), then glance at the other attributes to determine if I might be interested.

Using this approach on Tuesday, I quickly evaluated about 200 CA munis and about 1,600 non-CA munis that met my initial screens. I identified two small-lot CA munis (only 5 each available) that looked really good, and bought them.

I'm now almost out of cash available to buy munis, unless I decide to lower my liquid reserves in CA muni MM, now earning 2.20% TEY, or until some CDs in taxable mature later this year.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mydanyale » Thu Apr 19, 2018 10:12 pm

Iliketoridemybike wrote:
Sun Apr 15, 2018 6:47 pm
Mydanyale wrote:
Sun Apr 15, 2018 1:29 pm
Iliketoridemybike wrote:
Sun Apr 15, 2018 9:41 am
A lot of people buy and manage individual bonds and create bond ladders. Many do it well into their senior years. It isn’t rocket science. There are tools to help you setup what kind of cash flow you want, pick the duration and make sure you don’t reach into too many low credit offerings to get yield. I enjoy it. It is far better than watching my nest egg go down in an intermediate bond fund.
Once rates stabilize, I am not opposed to using a fund again, but as rates rise, I like a ladder. Though there are many on here that will disagree with that approach. I know, they have told me already. :D
Hi,
Would you mind sharing some of your favorite tools for selecting/purchasing your bond holdings?
Btw, I agree with you that individual bond holdings are overall safer than bond funds when higher interest rates are expected, despite the lack of diversification. That is precisely the reason I am trying to learn about it.
My favorite tools....
https://www.fidelity.com/fixed-income-b ... s/overview
Thank you! :sharebeer

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Fri Apr 20, 2018 3:25 am

Iliketoridemybike wrote:
Sun Apr 15, 2018 6:47 pm
Mydanyale wrote:
Sun Apr 15, 2018 1:29 pm
<snip>
It is far better than watching my nest egg go down in an intermediate bond fund.
Once rates stabilize, I am not opposed to using a fund again, but as rates rise, I like a ladder. Though there are many on here that will disagree with that approach. I know, they have told me already. :D
<snip>
Btw, I agree with you that individual bond holdings are overall safer than bond funds when higher interest rates are expected, despite the lack of diversification. That is precisely the reason I am trying to learn about it.
OK, we can't just let this go without some clarification.

It's important to understand that a rolling ladder of individual bonds is no safer than a bond fund with similar characteristics (average yield, duration, any concentration at various points on the yield curve, credit quality, etc.). A bond fund basically is a rolling bond ladder. A rolling bond ladder drops in value just as much as a bond fund of similar characteristics if yields rise. You can see this in the price quotes for your individual bonds if you pay attention.

Let's say you bought a 3-year Treasury one year ago at par value of 100 (somewhat hypothetical, but easiest way to demonstrate the concept--math is similar regardless of the details). Three-year Treasury yield on 4/19/2017 was 1.38% (https://fred.stlouisfed.org/graph/?g=jwjm), so if bought at par your coupon rate was 1.38%. On 4/19/2018 you now have a 2-year Treasury, and 2-year Treasury yield is 2.44% (https://www.treasury.gov/resource-cente ... data=yield). You can use the spreadsheet PRICE function to determine that the price of your 2-year bond at yield of 2.44% and coupon of 1.38% maturing 4/19/2020 is 97.94. So you have a capital return of -2.06% on this bond (97.94/100 -1).

This capital loss of 2.06% of the bond in your ladder would contribute the same loss to the decline in share price of a bond fund holding this bond. There is no difference whether you hold the bond in a ladder or in a bond fund.

If you think an intermediate-term bond fund has too much term risk (and you're worried about losing money if yields continue to rise, which they may or may not), then you could use a short-term bond fund instead. Or if that's still too much term risk for you, then you could use a money market fund.

OK, so why am I buying individual munis instead of just investing in a short-term or limited term tax-exempt bond fund? Well, I've articulated those reasons earlier in the thread, but here's a recap.

Vanguard does not offer a short-term CA muni bond fund, and IMO, the yield curve does not warrant extending maturity beyond three years. Duration of the CA intermediate-term bond fund is 5.2 years and average maturity is 9.0 years, so much more term risk than warranted, IMO. However, I continue to hold my existing position in this fund--I'm just not adding to it. Hedging my bets. Maybe yields won't continue to increase much from here--no one can predict this--no one.

VG limited term average maturity is 3.4 years, which means it's holding bonds of longer maturity than that. I own some of this, also as a hedge, but much more in the muni bond ladder I've built. Other problems are that in this fund I don't get the CA tax exemption for the CA munis, and I'm paying a premium for munis issued by NY and other high tax states without getting the state tax exemption.

VG short-term average maturity is 1.4 years, so closer to what I think is warranted in terms of term risk, but SEC yield is only 1.73%, and I can do better than that with my ladder. The fund holds 77% in AA or better, while I hold 100% in AA or better. Same problems with no tax-exemption for CA munis and overpaying for other high-tax state munis.

Sometimes I'm finding better TEYs for similar maturity and credit rating in non-CA munis, and sometimes in CA munis (and sometimes in Treasuries), so I can mix and match these to optimize risk-adjusted TEY, and I get the appropriate tax-exemption depending on whether I buy CA or non-CA munis. Can't do that with a fund.

Very importantly, I will not be rolling all proceeds from maturing bonds into new bonds, but will be using some of the proceeds to pay for residual living expenses in retirement. So a ladder better suits my needs for this part of my portfolio--somewhat of a liability matching thing rather than just a rolling ladder. So I don't have to sell shares of a bond fund after price declines--instead I can just spend from proceeds of maturing bonds, and let the other bonds recover their value as they approach par value at maturity. I still lose money if yields increase, just like a bond fund, but just not quite as much, since I'm not forced to sell longer-maturity bonds after recent price declines.

I just think it's important not to think that individual bond values don't go down when yields increase. They do, just like they do in a fund. Unless you have very specific reasons to prefer owning individual bonds, a Vanguard bond fund probably is the way to go. You get more diversification, much better liquidity, low cost, and simplicity.

This thread is about munis in taxable, but in tax advantaged, there can be advantages to owning CDs rather than bonds or bond funds, but that's a different discussion (and there is a current thread on that if you're interested).

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by chw » Fri Apr 20, 2018 4:29 am

hudson wrote:
Sat Apr 14, 2018 7:11 pm
Artsdoctor wrote:
Sat Apr 14, 2018 6:54 pm
The bond in question may indeed have a coupon of 5%. It's a premium bond and if the yield to maturity is under 2%, the premium is going to be high. But that's another conversation altogether.
Your insight is appreciated!
I do not understand how the yield can go from 5% to 2%.
In general, it is because one would be paying a premium above par of 3% at the time of purchase. Kevin does a nice job explaining this earlier in this thread.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Fri Apr 20, 2018 8:23 am

Kevin M wrote:
Fri Apr 20, 2018 3:25 am
OK, we can't just let this go without some clarification.

It's important to understand that a rolling ladder of individual bonds is no safer than a bond fund with similar characteristics (average yield, duration, any concentration at various points on the yield curve, credit quality, etc.). A bond fund basically is a rolling bond ladder. A rolling bond ladder drops in value just as much as a bond fund of similar characteristics if yields rise.
Kevin, methinks ye toil in vain. It is impossible to get to the vast majority of our fellow humans to understand the meaning of mark to market. This, always it shall be. Yet, I admire your persistence and clarity in the face of human limitations. :happy

I thought Vanguard published a state by state composition of its bond funds? http://www.vanguard.com/pdf/INBST_012018.pdf

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Fri Apr 20, 2018 9:00 am

gmaynardkrebs wrote:
Fri Apr 20, 2018 8:23 am
I thought Vanguard published a state by state composition of its bond funds? http://www.vanguard.com/pdf/INBST_012018.pdf

Californians typically get no tax break on the CA-bond income from a national muni fund; by state law a fund must hold 50+% CA-exempt assets in order for the part of its distributed interest derived from such bonds to be CA-exempt.
So the californian who also holds a CA-specific muni fund or individual CA bonds gets from a national fund a) somewhat less of the risk mitigation it provides via diversification to those who don't overweight CA munis; and b) the slightly lower yield per unit risk from the CA bond content (relative to bonds from states that generally tax income less so offer less incentive to their residents to hold in-state munis) without an associated state tax benefit.
Last edited by ofckrupke on Fri Apr 20, 2018 10:00 am, edited 2 times in total.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mehitabel » Fri Apr 20, 2018 9:57 am

Kevin M wrote:
It's important to understand that a rolling ladder of individual bonds is no safer than a bond fund with similar characteristics (average yield, duration, any concentration at various points on the yield curve, credit quality, etc.). A bond fund basically is a rolling bond ladder. A rolling bond ladder drops in value just as much as a bond fund of similar characteristics if yields rise. You can see this in the price quotes for your individual bonds if you pay attention.

Let's say you bought a 3-year Treasury one year ago at par value of 100 (somewhat hypothetical, but easiest way to demonstrate the concept--math is similar regardless of the details). Three-year Treasury yield on 4/19/2017 was 1.38% (https://fred.stlouisfed.org/graph/?g=jwjm), so if bought at par your coupon rate was 1.38%. On 4/19/2018 you now have a 2-year Treasury, and 2-year Treasury yield is 2.44% (https://www.treasury.gov/resource-cente ... data=yield). You can use the spreadsheet PRICE function to determine that the price of your 2-year bond at yield of 2.44% and coupon of 1.38% maturing 4/19/2020 is 97.94. So you have a capital return of -2.06% on this bond (97.94/100 -1).

This capital loss of 2.06% of the bond in your ladder would contribute the same loss to the decline in share price of a bond fund holding this bond. There is no difference whether you hold the bond in a ladder or in a bond fund.

But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control. Also, with individual bonds, the yield will not change. With a bond fund, it can.

Are those not the reasons that many choose to hold individual bonds?

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Fri Apr 20, 2018 10:48 am

deleted
Last edited by gmaynardkrebs on Fri Apr 20, 2018 11:52 am, edited 1 time in total.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mehitabel » Fri Apr 20, 2018 11:46 am

gmaynardkrebs wrote:
Fri Apr 20, 2018 10:48 am
Mehitabel wrote:
Fri Apr 20, 2018 9:57 am
Kevin M wrote:
It's important to understand that a rolling ladder of individual bonds is no safer than a bond fund with similar characteristics (average yield, duration, any concentration at various points on the yield curve, credit quality, etc.). A bond fund basically is a rolling bond ladder. A rolling bond ladder drops in value just as much as a bond fund of similar characteristics if yields rise. You can see this in the price quotes for your individual bonds if you pay attention.

Let's say you bought a 3-year Treasury one year ago at par value of 100 (somewhat hypothetical, but easiest way to demonstrate the concept--math is similar regardless of the details). Three-year Treasury yield on 4/19/2017 was 1.38% (https://fred.stlouisfed.org/graph/?g=jwjm), so if bought at par your coupon rate was 1.38%. On 4/19/2018 you now have a 2-year Treasury, and 2-year Treasury yield is 2.44% (https://www.treasury.gov/resource-cente ... data=yield). You can use the spreadsheet PRICE function to determine that the price of your 2-year bond at yield of 2.44% and coupon of 1.38% maturing 4/19/2020 is 97.94. So you have a capital return of -2.06% on this bond (97.94/100 -1).

This capital loss of 2.06% of the bond in your ladder would contribute the same loss to the decline in share price of a bond fund holding this bond. There is no difference whether you hold the bond in a ladder or in a bond fund.

But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control. Also, with individual bonds, the yield will not change. With a bond fund, it can.

Are those not the reasons that many choose to hold individual bonds?
I rest my case.

Kevin -- rest your case about what? Is my understanding incorrect? A broker I know (ok, my mom's) insists that if you hold bonds till maturity you don't have to worry about the (unrealized) capital losses. Not correct? Wrinkles he didn't mention? ?????

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Fri Apr 20, 2018 11:51 am

Mehitabel wrote:
Fri Apr 20, 2018 11:46 am

But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control. Also, with individual bonds, the yield will not change. With a bond fund, it can.

My apologies to you and to Kevin, I interjected my comment, which I should not have done. I will take it down, and allow Kevin to answer, as I should have done in the first place. Again, my apologies.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Fri Apr 20, 2018 1:49 pm

Mehitabel wrote:
Fri Apr 20, 2018 9:57 am
Kevin M wrote:
It's important to understand that a rolling ladder of individual bonds is no safer than a bond fund with similar characteristics (average yield, duration, any concentration at various points on the yield curve, credit quality, etc.). A bond fund basically is a rolling bond ladder. A rolling bond ladder drops in value just as much as a bond fund of similar characteristics if yields rise. You can see this in the price quotes for your individual bonds if you pay attention.

Let's say you bought a 3-year Treasury one year ago at par value of 100 (somewhat hypothetical, but easiest way to demonstrate the concept--math is similar regardless of the details). Three-year Treasury yield on 4/19/2017 was 1.38% (https://fred.stlouisfed.org/graph/?g=jwjm), so if bought at par your coupon rate was 1.38%. On 4/19/2018 you now have a 2-year Treasury, and 2-year Treasury yield is 2.44% (https://www.treasury.gov/resource-cente ... data=yield). You can use the spreadsheet PRICE function to determine that the price of your 2-year bond at yield of 2.44% and coupon of 1.38% maturing 4/19/2020 is 97.94. So you have a capital return of -2.06% on this bond (97.94/100 -1).

This capital loss of 2.06% of the bond in your ladder would contribute the same loss to the decline in share price of a bond fund holding this bond. There is no difference whether you hold the bond in a ladder or in a bond fund.
But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control.
It is only a benefit if you are spending at least some of the proceeds from maturing bonds, as I explained.

One thing I didn't mention in that explanation is that if you don't roll the entire proceeds of maturing bonds into bonds at the long end of your ladder maturity range, then the duration of you ladder is gradually decreasing, as opposed to a bond fund that will maintain a relatively stable duration. So in this sense the non-rolling ladder is safer for liability matching, because the duration of your ladder is decreasing as the duration of your liabilities is decreasing.

So the living expenses I pay from my ladder in three years will be met with proceeds of my bonds that mature in three years. In a fund, I could be forced to sell shares shortly after a large increase in yields of bonds in the fund, and in selling these shares I'm selling the longer term bonds that might have had larger decreases in value, as well as the shorter-term bonds that might have lost less, and I have no opportunity to use only the proceeds from bonds that are maturing when I need the money.

Some people prefer to gradually move from say intermediate-term to short-term funds as the duration of their liabilities decreases, but I don't think this is quite as good as a ladder for liability matching, and there are other reasons to own the ladder, as I've explained.

Your ladder loses value when yields increase, just like a bond fund does. So if you look at the return of a bond ladder established a few months ago, it has lost value because yields on those bonds have increased. The bond math that applies to bonds in a fund applies exactly the same way to the bonds in your ladder.
Also, with individual bonds, the yield will not change. With a bond fund, it can.
Not so. The yield of a bond fund is just the weighted average of the yield of the bonds in the fund. How can the yield of a bond fund change if the yields of the bonds it owns doesn't change? The yields and prices of the bonds in your ladder change just as they do for the bonds in a fund.

Note that whenever we say "yield" without qualification, we are talking about yield to maturity (YTM), since this is the yield that is most relevant to your expected return (especially if bond is held to maturity).
Are those not the reasons that many choose to hold individual bonds?
It may be, but only because whoever does so doesn't understand bond math, and the similarity of a rolling bond ladder to a bond fund of similar characteristics.

It might be easier to think of it in terms of opportunity cost. Bonds of a given maturity, say two years, can now be bought at lower prices and higher yields than bonds bought at pretty much any time in the last year. Just this month, 2-year Treasury yield has increased from 2.25% to 2.44%, going by https://www.treasury.gov/resource-cente ... data=yield, which is a good starting point; when I looked earlier today, I could buy a 2-year Treasury in small quantities at a yield of 2.446%, so pretty close to what we see at Treasury.gov.

So I would earn about 2.25% on a 2-year Treasury I bought on April 2, but if I buy it today I will earn about 2.45%, all assuming I hold to maturity. No one will pay me what I paid at the beginning of the month, with yields 20 bps higher than they were when I bought, and with the bond only having a little less than three weeks less to maturity. Since I bought the bond on 4/2, I can't use that money to buy the bond today, so I have lost the opportunity to buy the bond at the higher yield--opportunity cost.

Since I'm holding to maturity, I don't have to realize the loss, and will earn about the 2.25% I expected when I bought the bond, so that's a benefit of a non-rolling ladder. I could sell the bond at a loss and buy the bond back at the higher yield, but because I'd take a loss on the sale, I'll still end up earning about 2.25% at maturity--probably a little less due to the bid/ask spread (you get less when you sell the bond than when you buy it).

It should be noted that the bond fund may not hold the bond to maturity. So they may sell it at a loss when it hits the lower end of their maturity range guideline, but then they will use the proceeds to buy a higher-yielding bond at the upper end of their maturity range. On the other hand, if the yield curve doesn't change much, or if yields fall, they could realize a gain on this transaction. You could do this in your ladder too, but for CDs or munis, the bid/ask spread and commissions we pay as retail investors will cut into this potential gain (or amplify the potential loss), so this probably only is a reasonable strategy for a Treasury ladder.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mehitabel » Fri Apr 20, 2018 7:48 pm

Thanks, Kevin.

I appreciate your taking the time to write that long, detailed explanation.

You wrote:
Very importantly, I will not be rolling all proceeds from maturing bonds into new bonds, but will be using some of the proceeds to pay for residual living expenses in retirement. So a ladder better suits my needs for this part of my portfolio--somewhat of a liability matching thing rather than just a rolling ladder. So I don't have to sell shares of a bond fund after price declines--instead I can just spend from proceeds of maturing bonds, and let the other bonds recover their value as they approach par value at maturity. I still lose money if yields increase, just like a bond fund, but just not quite as much, since I'm not forced to sell longer-maturity bonds after recent price declines.
I'm currently using bond proceeds for retirement income as well, so I'm thinking that individual bonds, rather than funds, would be more appropriate for me as well.

-Mehitabel

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by mindbogle » Mon Apr 23, 2018 8:28 am

So what do the muni bond experts think of iShares iBonds Sep 2020 Term Muni Bond ETF (IBMI) as a proxy for 2-yr AA Muni?

SEC Yield of 1.65%
Avg Mat=2.2
Almost 90% AA rating or better
#Holdings >1000
ER=.18%
Discount/Premium close to 0...

Thanks,

MB

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Mon Apr 23, 2018 8:39 am

mindbogle wrote:
Mon Apr 23, 2018 8:28 am
So what do the muni bond experts think of iShares iBonds Sep 2020 Term Muni Bond ETF (IBMI) as a proxy for 2-yr AA Muni?

SEC Yield of 1.65%
Avg Mat=2.2
Almost 90% AA rating or better
#Holdings >1000
ER=.18%
Discount/Premium close to 0...

Thanks,

MB
For me, with Vanguard Municipal Money Market Fund at 1.52%, no term risk, no. However, while VMSXX has been at or near that all this month, has been more variable in previous months. The ETF is not much of a proxy for the 2 year bond, as the duration will be constant.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Mon Apr 23, 2018 10:59 am

mindbogle wrote:
Mon Apr 23, 2018 8:28 am
So what do the muni bond experts think of iShares iBonds Sep 2020 Term Muni Bond ETF (IBMI) as a proxy for 2-yr AA Muni?

SEC Yield of 1.65%
Avg Mat=2.2
Almost 90% AA rating or better
#Holdings >1000
ER=.18%
Discount/Premium close to 0...

Thanks,

MB
Today I bought an AA+ CA muni at 1.602% net maturing 10/1/2018, so 0.44 year maturity, and I get the state tax exemption which I wouldn't get with the fund. For me this is TEY of 2.465%, so 57 bps/year relative to 0-year CA muni MM at 2.20% TEY.

For non-CA, I see an AA+ IN muni at 1.827% net maturing 1/15/2019, so 0.73 year maturity. This is TEY of 2.586% for me, so about 51 bps/year relative to Prime MM at 1.79%.

I see AAA TX muni at 2.016% net maturing 3/1/2020, so 1.86 year maturity.

For 2.2 year maturity, 1.65% doesn't look attractive to me, but the SEC yield lags and yields have been increasing, so this should come up over next 30 days.

The thing about individual munis is you can pick off the best deals, and if you stick with AA/AAA with maturity of 3-year or less, credit risk is minimal, so I don't feel I need as much diversification as a fund that must buy much larger quantities so can't be as selective. Of course buying individual munis is much more complicated and time consuming.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Mon Apr 23, 2018 11:24 am

Kevin M wrote:
Mon Apr 23, 2018 10:59 am
Today I bought an AA+ CA muni at 1.602% net maturing 10/1/2018, so 0.44 year maturity, and I get the state tax exemption which I wouldn't get with the fund. For me this is TEY of 2.465%, so 57 bps/year relative to 0-year CA muni MM at 2.20% TEY.
[...]
Of course buying individual munis is much more complicated and time consuming.
Folks playing at home might like to know that based on a 10k investment the difference in return over the 0.44y between these two - expected, of course, because who knows what the muni MMF will actually earn between now and 10/1/2018, or whether Kevin will flip the bond before it matures - is about $7.33 (tax-free, of course).

gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Mon Apr 23, 2018 11:42 am

ofckrupke wrote:
Mon Apr 23, 2018 11:24 am
Kevin M wrote:
Mon Apr 23, 2018 10:59 am
Today I bought an AA+ CA muni at 1.602% net maturing 10/1/2018, so 0.44 year maturity, and I get the state tax exemption which I wouldn't get with the fund. For me this is TEY of 2.465%, so 57 bps/year relative to 0-year CA muni MM at 2.20% TEY.
[...]
Of course buying individual munis is much more complicated and time consuming.
Folks playing at home might like to know that based on a 10k investment the difference in return over the 0.44y between these two - expected, of course, because who knows what the muni MMF will actually earn between now and 10/1/2018, or whether Kevin will flip the bond before it matures - is about $7.33 (tax-free, of course).
To go Shakespeare on you, if you enjoy the game, and TurboTax too, it's As You Like It. For the rest of us, Much Ado About Nothing.

happenstance
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by happenstance » Mon Apr 23, 2018 10:51 pm

Another great fixed-income thread from Kevin. A couple of comments/questions:

Are you screening out callable bonds in your search? Call options seem like they would create a hassle when managing an individual bond portfolio, especially at the maturities you purchase.

Have you only looked on the secondary market, or do you also consider new issues?

I ask because in The Only Guide to a Winning Bond Strategy You'll Ever Need,
Larry Swedroe wrote:The conclusion we can draw is that if an investor limits herself to bonds of the highest quality and has a portfolio of perhaps $500,000, she could consider building her own portfolio, saving the costs of a mutual fund or ETF. A $500,000 portfolio would allow her to purchase securities in large enough blocks that she could limit the markups and markdowns to acceptable levels, and she could diversify the credit risk across perhaps as many as ten issuers.
[...]
It is unlikely that individuals acting on their own will be able to obtain institutional prices. Thus even do-it-yourself investors with a $500,000 or larger portfolio should limit them-selves to buying in the new-issue market, where they can be assured that they are getting institutional pricing. They should also only buy individual bonds if they are virtually certain that they will be able to hold the bonds to maturity.
But it does appear possible to exercise control over the markup on the secondary market. The impact of the commission is calculable, so it the main concern is the spread. This thread shows there are some good deals out there—even at smaller lot sizes—and you can figure the exact yield you get at time of purchase.

I've been poking around on Schwab's fixed income site, and I notice that new issue munis come in two offering styles: negotiated and competitive. At Schwab, you can only place online orders for negotiated new issues, while competitive ones require calling a Fixed Income Specialist. And unlike on the secondary market, it seems you don't know the exact allocation and pricing you get until after the order settles. So to my (admittedly untrained) eyes, the secondary market is in some ways preferable to the primary market.

As I'm currently in the accumulation stage, I do not need the complexity of an individual muni bond portfolio right now (iShares New York Muni Bond ETF/NYF meets my needs well). But later on I could see adopting an individual bond portfolio, and I may purchase a muni bond or two in the interim just to get a sense of the mechanics.

stlutz
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by stlutz » Mon Apr 23, 2018 11:41 pm

But it does appear possible to exercise control over the markup on the secondary market. The impact of the commission is calculable, so it the main concern is the spread. This thread shows there are some good deals out there—even at smaller lot sizes—and you can figure the exact yield you get at time of purchase.
If you're focused on the spread in the secondary market, you're focused on the wrong thing. If a product I want normally costs $50 and I can buy it on sale for $30, should I be worked up if the store owner still made $10?

All that matters is the price you pay and whether you get value for what you buy. As Kevin has shown, the best "deals" in the muni market tend to be in small lots. The middlemen are still taking their cut out of the transaction--but it's the original seller who took the bit hit.

If one is sticking with the highest rated bonds, they don't need $500,000 before buying an individual muni bond. Ten $5K AAA bonds makes for a nice collection of holdings.

Individual muni bonds really don't offer big advantages over a fund, and in the overwhelming majority of cases, a fund is a better choice simply because it's so much simpler and [generally] more liquid. But your children aren't going to have two heads because you once bought a couple of individual bonds either.

Disclosure: I own muni funds and a few individual muni bonds.

stlutz
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by stlutz » Mon Apr 23, 2018 11:47 pm

But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control.
Muni bonds are rarely issued or trade at par. Suppose someone buys a bond for $110 and it pays $5 in interest per year. At maturity, they get $100 back.

Did this person get their money back at maturity? If not, what would they need to do to make sure they did?

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