Treasuries in higher tax state

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Name=Random
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Treasuries in higher tax state

Post by Name=Random » Sun Oct 14, 2018 5:58 pm

Are treasuries a pretty good deal when compare to other risk free investments? I could put cash in an FDIC insured CD or it seems to me i could put it in a 1 year treasury. If my googling is right, then a 1 year treasury currently pays 2.66% return and is state tax free. If one is in a 9.3% state tax bracket than that's a 2.66/(1-0.093) = 2.93% return. I don't think there are 1 year CDs out there with 2.93% return. Is my logic sound?

How do i go about purchasing treasuries with my vanguard brokerage account and are there costs that will eat into my returns that i'm not accounting for?

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grabiner
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Re: Treasuries in higher tax state

Post by grabiner » Sun Oct 14, 2018 9:21 pm

If you buy Treasury bonds in a brokerage account, you will pay spreads, just as on any other trade in a brokerage account. However, spreads on Treasuries are very low. Alternatively, you can buy new-issue Treasury bonds from Treasury Direct.

Another way to invest in Treasury bonds is through a Treasury mutual fund. You would then pay expenses, but the fund would be easier to manage because you can buy and sell in any amount at any time. (In contrast, Treasury bonds trade in $1000 multiplies.)
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smectym
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Re: Treasuries in higher tax state

Post by smectym » Sun Oct 14, 2018 11:57 pm

OP, you’re definitely on to something.

Yes, if a saver in a high-tax state (like mine) opts for a bank CD “because its insured by the FDIC,” and ignores the option of direct, commission- and fee-free investing in Treasury securities through Treasury Direct, that saver is probably getting the short end today—as treasury yields have started to rise from historically unprecedented low levels.

Leading brokerages also offer treasuries and some have commission-free deals; great. I think Treasury Direct does a pretty good job “for government work.” That’s where I buy everything from 3-month bills through notes and bonds, plus I and EE savings bonds.

Over the course of years, legally skirting the obligation to forfeit 9%, 10% or more of earnings annually to the state really adds up. Remember, people on this forum hyperventilate and break out into hives over fund expense ratios of far less than 1%—never mind 10%. So if a definitionally risk-free alternative to bank CD’s offers the same or better yield , + state tax immunity...go for it

Smectym

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Re: Treasuries in higher tax state

Post by smectym » Mon Oct 15, 2018 12:11 am

grabiner wrote:
Sun Oct 14, 2018 9:21 pm
If you buy Treasury bonds in a brokerage account, you will pay spreads, just as on any other trade in a brokerage account. However, spreads on Treasuries are very low. Alternatively, you can buy new-issue Treasury bonds from Treasury Direct.

Another way to invest in Treasury bonds is through a Treasury mutual fund. You would then pay expenses, but the fund would be easier to manage because you can buy and sell in any amount at any time. (In contrast, Treasury bonds trade in $1000 multiplies.)
The Treasury Direct minimum is currently $100 and multiples thereof—not $1000.

Smectym

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Re: Treasuries in higher tax state

Post by tfb » Mon Oct 15, 2018 12:14 am

Name=Random wrote:
Sun Oct 14, 2018 5:58 pm
How do i go about purchasing treasuries with my vanguard brokerage account and are there costs that will eat into my returns that i'm not accounting for?
You can buy new-issue Treasury bonds in Vanguard brokerage account at no cost. Select Transact, then scroll down to find "Trade bonds or CDs" at the bottom of the dropdown. Click on the Treasuries tab, then the Auction radio button. The issues available to buy will have a buy link. In the buy order screen, quantity 1 = $1,000 in face value. Check on Thursday afternoon for a new batch for sale in the following week. Or Google Treasury auction calendar.
Harry Sit, taking a break from the forums.

Name=Random
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Re: Treasuries in higher tax state

Post by Name=Random » Mon Oct 15, 2018 1:38 am

Thanks everyone for the advice. This looks like a pretty good option for me. The other thing i'm curious about is bond funds.

How does the return on treasuries compare to something like a total US bond market fund? Would i get a significantly higher return on the bond fund at a higher risk? My understanding is that bond fund prices drop as interest rates go up, so it sounds like there is a high chance of negative return in the coming years. At least with a CD or treasury my return would be always positive (if i ignore inflation). Am i missing something and bond funds are actually a good option for comparable or better returns?

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grabiner
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Re: Treasuries in higher tax state

Post by grabiner » Mon Oct 15, 2018 7:48 am

Name=Random wrote:
Mon Oct 15, 2018 1:38 am
How does the return on treasuries compare to something like a total US bond market fund? Would i get a significantly higher return on the bond fund at a higher risk? My understanding is that bond fund prices drop as interest rates go up, so it sounds like there is a high chance of negative return in the coming years. At least with a CD or treasury my return would be always positive (if i ignore inflation). Am i missing something and bond funds are actually a good option for comparable or better returns?
The price of any bond decreases if the yield on that bond goes up; it doesn't matter whether the bond is in a fund or held directly. Individual bonds, like bond funds, have a duration, which is the time required to make up this decline. If you buy a 5-year Treasury, which has a duration close to 5 years (not exactly 5 because of coupon payments), and 5-year Treasury rates rise 1%, your bond will be worth 5% less than you paid for it. However, your returns will be increased by 1% per year, so that you get back the par value when the bond matures.

You would expect a higher return on Total Bond Market, because it holds bonds which have other types of risk. GNMAs are guaranteed by the Treasury, but they gain less than indicated by their duration when interest rates fall because homeowners refinance their mortgages. Corporate bonds sometimes default. This is why Vanguard Intermediate-Term Treasury Index Admiral has a 2.95% yield, and Total Bond Market Index Admiral has a 3.32% yield (with a slightly higher duration).

Also important is "on that bond". The rate which is expected to rise is the federal funds rate, which is the rate for very-short-term loans. Longer-term rates are set by bond traders, who already know about expected changes in short-term rates, and price the bonds accordingly. The current yield on intermediate-term bonds isn't much higher than on short-term bonds, which means that bond traders don't expect intermediate-term rates to rise significantly. (Even if traders expect rates to be stable, intermediate-term yields should be higher, because there is more risk.)
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cas
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Re: Treasuries in higher tax state

Post by cas » Mon Oct 15, 2018 8:11 am

Name=Random wrote:
Sun Oct 14, 2018 5:58 pm
If one is in a 9.3% state tax bracket than that's a 2.66/(1-0.093) = 2.93% return.
Incidentally, that is the correct formula for determining the taxable equivalent yield for the Treasury if you are able to fully deduct your state taxes on your federal return.

But, under the new tax bill, many more people will be taking the standard deduction (i.e. not deducting their state taxes on there federal return), so it is probably worth mentioning that a different equation applies in that case. Kevin M wrote up a nice post deriving various Taxable Equivalent Yield (TEY) equations, which can be found here: "Taxable Equivalent Yield (TEY)" viewtopic.php?t=248539

Bottom line equation from that post:
Where f and s = federal and state marginal tax rates, Yt is Treasury yield

Treasury: TEY = Yt * (1-f) / (1 - f - s)

hpryder
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Re: Treasuries in higher tax state

Post by hpryder » Mon Oct 15, 2018 12:57 pm

An alternative to buying treasuries on the 2ndary broker market or Treasury Direct, is Fidelity no commission (ie free) treasure auction purchase. Addition it seems Fidelity also has an automatic free repurchase at maturity option.

Fidelity is where I'm making a T bill ladder.

mervinj7
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Re: Treasuries in higher tax state

Post by mervinj7 » Mon Oct 15, 2018 1:09 pm

grabiner wrote:
Sun Oct 14, 2018 9:21 pm
If you buy Treasury bonds in a brokerage account, you will pay spreads, just as on any other trade in a brokerage account. However, spreads on Treasuries are very low. Alternatively, you can buy new-issue Treasury bonds from Treasury Direct.
Both Vanguard and Fidelity allow the purchase of new-issue Treasury securities at auction for no commission. Fidelity has a slight advantage here with an Auto Roll service that automatically repurchases the security with the same maturity when the initial investment matures. It's a fantastic service for those who want to built a self-managed Treasury ladder.

https://www.fidelity.com/fixed-income-b ... ll-program

MnD
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Re: Treasuries in higher tax state

Post by MnD » Mon Oct 15, 2018 1:16 pm

grabiner wrote:
Sun Oct 14, 2018 9:21 pm
If you buy Treasury bonds in a brokerage account, you will pay spreads, just as on any other trade in a brokerage account. However, spreads on Treasuries are very low. Alternatively, you can buy new-issue Treasury bonds from Treasury Direct.
Schwab also and probably others.
Just purchased my monthly ladder rung of 13-weeks today at Schwab via non-competitive offer and received the exact price and yield that the big-boys get with $0 fees, commissions or spreads.

If one needed to sell before maturity the bid/ask spread is minimal.
For example the current bid/ask spread on a t-bill 12 weeks out amounts to 10 cents per $10,000!
CUSIP 912796QS1
Quote Bid Ask
Price 99.468 99.467
Yield To Maturity 2.270% 2.273%

Day9
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Re: Treasuries in higher tax state

Post by Day9 » Mon Oct 15, 2018 1:22 pm

smectym wrote:
Sun Oct 14, 2018 11:57 pm
...
Over the course of years, legally skirting the obligation to forfeit 9%, 10% or more of earnings annually to the state really adds up. Remember, people on this forum hyperventilate and break out into hives over fund expense ratios of far less than 1%—never mind 10%.
I agree with your post in general but you pay state income tax on the income return from the fixed income investment (e.g. 10% of the 3% yield), whereas expense ratio fees are calculated based on the entire amount you had invested (e.g. 1% of your entire amount invested). Maybe this is a pedantic thing to point out but let's be clear so we only start hyperventilating and breaking out in hives when it's appropriate!
I'm just a fan of the person I got my user name from

EvelynTroy
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Re: Treasuries in higher tax state

Post by EvelynTroy » Tue Oct 16, 2018 8:07 am

Name=Random wrote:
Sun Oct 14, 2018 5:58 pm
Are treasuries a pretty good deal when compare to other risk free investments? I could put cash in an FDIC insured CD or it seems to me i could put it in a 1 year treasury. If my googling is right, then a 1 year treasury currently pays 2.66% return and is state tax free. If one is in a 9.3% state tax bracket than that's a 2.66/(1-0.093) = 2.93% return. I don't think there are 1 year CDs out there with 2.93% return. Is my logic sound?

How do i go about purchasing treasuries with my vanguard brokerage account and are there costs that will eat into my returns that i'm not accounting for?
You might be interested in recent discussion on this topic on Personal Investing board. I was asking about best CD to purchase - KevinM who is quite knowledgeable on fixed income options suggested the 6 mo. Treasury Bill - gave calculations, and good explanation. I purchased them yesterday and gave the following regarding my experience - fwiw. My guess is Vanguard would work the same way as Schwab.

viewtopic.php?f=2&t=260750#p4155545

I purchased the Treasury bills today at my local Schwab office. Worked out very well - I purchased 6 month Treasury Bills @ 2.45% which give a tax equivalent yield of 2.60%. I pay state income tax - these are state tax free.
@ 2.45% there is no better yield on a 6 month instrument of any kind in the country that I could find.
Currently best 6 mo. CD's are 2.26% brokered CD's and a 15 mo credit union one @2.75.
Other advantages:
I had the proceeds from a CD that matured in a check that the credit union mailed me.
That check did not have to clear - so my money went to work immediately.
There were no commissions or fees to purchase the Treasury bills.
When it comes due its automatically redeemed and proceeds put in my Schwab cash account - don't have to keep up with the maturity date.
Bank/cu CD's there is almost always an early withdrawal penalty - something you have to watch before you purchase that CD. Brokered CD's its costly to sell a CD before maturity.
Treasury you can sell partial amount before maturity or entire thing and is far less costly than early withdrawal of bank or brokered CD.
Also it helps simplify my portfolio, no additional account to open at a bank/cu for a CD. Keeping it simple always good.


Things in here you probably already know - maybe helpful to someone else.
Evelyn

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