Benchmark for Tax Equivalent Yield?

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bck63
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Benchmark for Tax Equivalent Yield?

Post by bck63 » Sat Dec 08, 2018 6:27 am

I keep reading that municipal bonds in taxable accounts are only beneficial for the higher tax brackets. However, when I do the math for intermediate term bonds, that doesn't seem to be the case for me. I'm just trying to find out if I'm missing something.

I am in the 22% federal bracket and 5.5% state bracket. There is no muni fund for my state (Connecticut).

When I look at the ten-year performance of the Vanguard Intermediate-Term Tax Exempt Fund (VWITX), the yield has been 4.14% -- a tax equivalent yield for me of 5.3%.

When I look at the ten-year performance of the Vanguard Intermediate-Term Bond Index Fund (VBILX), the ten-year yield is 4.95%.

When I look at current yields, VWITX tax equivalent yield is 3.397% vs 3.57% for VBILX.

What is the correct benchmark to use for measuring tax equivalency? Am I missing anything?

Thanks for any insights.

livesoft
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Re: Benchmark for Tax Equivalent Yield?

Post by livesoft » Sat Dec 08, 2018 8:13 am

When you write "ten-year performance" is that really 10-year yield or is that total return which includes capital gains/losses, too?

You may wish to use triceratop's spreadsheet for a more complete analysis and better understanding of how things are taxed: viewtopic.php?t=242137
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bck63
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Re: Benchmark for Tax Equivalent Yield?

Post by bck63 » Sat Dec 08, 2018 9:41 am

livesoft wrote:
Sat Dec 08, 2018 8:13 am
When you write "ten-year performance" is that really 10-year yield or is that total return which includes capital gains/losses, too?

I compared the ten-year returns from the fund profiles. Wrong way to do it?

You may wish to use triceratop's spreadsheet for a more complete analysis and better understanding of how things are taxed: viewtopic.php?t=242137
I found this confusing, which says more about me than the spreadsheet. :-)

bck63
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Re: Benchmark for Tax Equivalent Yield?

Post by bck63 » Sat Dec 08, 2018 11:19 am

livesoft wrote:
Sat Dec 08, 2018 8:13 am
When you write "ten-year performance" is that really 10-year yield or is that total return which includes capital gains/losses, too?

Yes. That's how I compared. Wrong way to do it?

betablocker
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Re: Benchmark for Tax Equivalent Yield?

Post by betablocker » Sat Dec 08, 2018 11:31 am

One factor may be the additional diversification of total bond versus just munis.

betablocker
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Re: Benchmark for Tax Equivalent Yield?

Post by betablocker » Sat Dec 08, 2018 11:32 am

Total bond also has a slightly higher duration and lower expense ratio.

bck63
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Re: Benchmark for Tax Equivalent Yield?

Post by bck63 » Sat Dec 08, 2018 1:01 pm

Okay thanks betablocker. That slows my heart down a bit in terms of worrying. :-)

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dratkinson
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Re: Benchmark for Tax Equivalent Yield?

Post by dratkinson » Sat Dec 08, 2018 5:10 pm

BH Benchmark for Tax Equivalent Yield


The total bond market index fund (TBM) is the one cited in the 3-fund portfolio, so it's the one I use as a benchmark.

In total market investing (capital appreciation + distributions), distributions are the major component of bond fund total return. So, within reason*, I prefer more distributions to less. And since I'm not planning to sell anytime soon, I don't worry (too much) about price fluctuations. (* I don't use HY muni fund due to AMT.)



I seem to be more risk tolerant than most, and can afford to be. You should know your true risk tolerance and perform your due diligence before using muni funds. Due diligence with Vanguard funds is easier; it’s more difficult with unknown funds.
--Search/read forum topics discussing due diligence.
--Search/read how Larry Swedroe chooses individual munis for his clients.


I first used munis in the 15% fed tax bracket, approaching the 25% bracket. Why? They kept me in the 15% tax bracket an additional ~5yrs so keeping QDI*/LTCG taxed at 0%. (* >90% of TSM, ~70% of TISM.)
--LT national muni always produced more after-tax income than TBM. I used it as my major bond holding.
--IT national muni did not always product more after-tax income than TBM, but it did produce more after-tax income than most CDs. I used it as a CD substitute with no early withdrawal penalty. (One year* of liquid living expense in checking, savings, mmkt reduces chance I’d need to tap my 3yrs EF-tier in IT muni.)
--Shorter duration munis were non-starters, as TBM produced more but would bump tax bracket.

* Money is fungible. I pay my annual living expenses by ABP (automatic bill payment) using a 2% CC. That 2% cashback on 1yr of living expenses is tax-free.
--Earning 2%/yr tax-free makes it easy to keep 1yr of living expense liquid as my first EF tier.
--Since CC cashback is not reported on Sch B part I, my AGI is not increased, so better than bank interest.
--Not needing to chase bank teaser rates, because I get 2%/yr tax-free from a CC, keeps my life simple.


The use of munis in lower tax brackets is reported to be more risky than using TBM. I have not seen this risk appear during my use of them. (Maybe because Vanguard funds are reported to be less risky than most.)


All bonds/funds are affected by interest rate risk---longer durations more so. The evidence for this has been declining NAVs as interest rates have risen.
--As I don’t need to sell, the declining NAVs have not affected me, except to TLH.
--Declining NAVs are offset by the increasing dividends produced by the same interest rate increases.


Any Federal Reserve short-term yield inversion---often-discussed topic---making shorter durations more desirable, should hopefully, quickly correct itself.


When comparing yields and interest rates,
--Ensure you use the muni "SEC Yield" in your taxable-equivalent yield calculation.
--Then compare the muni TEY to taxable bond/fund "SEC Yield" or CD/savings "APY".



Single state munis. Vanguard didn't have one. So I searched and found one I could live with. (If interested search forum for "My Colorado muni bond fund WTCOX" topic, in which I describe my due diligence.)

The forum's advice is to pair single-state/national munis 50/50 to limit single-state munis risk.

Beware, there are a lot of bad single-state munis out there. Follow the forum’s advice to cull them.



Edit. Completeness.
Last edited by dratkinson on Sun Dec 09, 2018 4:33 pm, edited 1 time in total.
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

bck63
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Re: Benchmark for Tax Equivalent Yield?

Post by bck63 » Sun Dec 09, 2018 1:09 pm

Thank you for your response dratkinson.

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