Historical muni bond returns for retirement calculators

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travis_nyc
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Historical muni bond returns for retirement calculators

Post by travis_nyc »

I've been making heavy use of various FIRE calculators to evaluate risk of investment and spending strategies, and have been doing some of my own calculations for my own particular situation. It's common for the calculators to ignore taxes and from what I can see use taxable bond returns. I suppose this is fine if all your money is in tax-advantaged accounts, but what if you have a big taxable account? I generally handle taxes by assuming that some percentage of actual spending is lower than the entered amount by approximate tax burden. But, most people investing in taxable accounts in high brackets will use municipal bonds, which have different returns that taxable bonds.

I'd like to do some of my own retirement calculators making use of municipal bonds because I think using taxable bonds in these calculators is overstating expected returns, particularly during periods of high yields (that we seem to be entering now).

Is anyone aware of any sources for municipal bond historical data? Firecalc and CfireSim use Shiller's GS10 (10-year yield on US Treasuries), but I can't find similar historical data for tax-exempt bonds. Or maybe, even if imperfect, there's a reasonable formula for calculating approximate municipal bond yields (and also therefore returns) based on treasury yields?

This paper suggests a reasonably linear relationship association between yields of treasuries and municipal bonds ( https://www.westernasset.com/us/en/pdfs ... 2015-04.pd ), although the exact slope of the relationship diverges a bit at very low yields (the yields become more equivalent).

I'm thinking that I could take the GS10 treasury yields and get an approximate 10-year muni rate based on the paper: muni_rate = 0.651 * GS10 + 0.834, except below 1.5% treasury yields where the ratio is close to 1:1, but I don't know if this relationship has held for longer periods (or at yields even higher than the period looked at in the whitepaper, which only goes back to the early 1990s)

Are there any better resources to look at for historical tax-exempt bond returns?
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vineviz
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Re: Historical muni bond returns for retirement calculators

Post by vineviz »

travis_nyc wrote: Fri Sep 16, 2022 4:05 pm I'd like to do some of my own retirement calculators making use of municipal bonds because I think using taxable bonds in these calculators is overstating expected returns, particularly during periods of high yields (that we seem to be entering now).
Keep in mind that using historical bond returns will generally overstate expected returns because bond yields have historically been greater than they are now. Probably the best estimate to use for future bond returns is their current yield-to-maturity.

That said, the pre-tax return of municipal bonds has historically been similar to the pre-tax return of Treasury bonds. And there are a couple of mutual funds with a long history of returns in PortfolioVisualizer.

https://www.portfoliovisualizer.com/bac ... n3_1=33.33
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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travis_nyc
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Re: Historical muni bond returns for retirement calculators

Post by travis_nyc »

vineviz wrote: Fri Sep 16, 2022 4:42 pm That said, the pre-tax return of municipal bonds has historically been similar to the pre-tax return of Treasury bonds. And there are a couple of mutual funds with a long history of returns in PortfolioVisualizer.

https://www.portfoliovisualizer.com/bac ... n3_1=33.33
Maybe I'm misunderstanding, but when I compare similar duration municipal bonds with treasury bonds in PortfolioVisualizer, I get wildly different returns. For example, in 2008, muni bonds had a negative return and treasury bonds had a positive return, vice versa in 2009, and in 2010 treasury bonds outperformed munis significantly, while munis outperformed in 2011. This is all before considering taxes. Over the long term, the treasury bonds outperform the munis, which you would expect because taxes aren't being taken into account.

If I were to use the historical data for treasury bonds like firecalc and cfiresim, the calculators would imply a higher rate of success (and higher portfolio end values) than if they could use muni bond returns.
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vineviz
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Re: Historical muni bond returns for retirement calculators

Post by vineviz »

travis_nyc wrote: Fri Sep 16, 2022 7:34 pm Maybe I'm misunderstanding, but when I compare similar duration municipal bonds with treasury bonds in PortfolioVisualizer, I get wildly different returns. For example, in 2008, muni bonds had a negative return and treasury bonds had a positive return, vice versa in 2009, and in 2010 treasury bonds outperformed munis significantly, while munis outperformed in 2011. This is all before considering taxes. Over the long term, the treasury bonds outperform the munis, which you would expect because taxes aren't being taken into account.

If I were to use the historical data for treasury bonds like firecalc and cfiresim, the calculators would imply a higher rate of success (and higher portfolio end values) than if they could use muni bond returns.

You're bound to see year-to-year differences in returns, but I don't think there's any good reason to imagine that the pre-tax returns should be wildly different over (what I presume for you) is a long planning horizon.

And as far as I can tell, historically they have not been, whether you compare munis to similar duration Treasuries or even a combination of Treasuries and short-term corporate bonds.

Image
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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travis_nyc
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Re: Historical muni bond returns for retirement calculators

Post by travis_nyc »

but I don't think there's any good reason to imagine that the pre-tax returns should be wildly different over (what I presume for you) is a long planning horizon.
If the market is at all efficient, the pre-tax returns of munis should be lower as their prices will be bid up by people who pay taxes, shouldn't it? Yields over the past few years have been so low that the differences would be smaller (and indeed the paper I referred to showed a different relationship between munis and treasuries at very low yields).

In the portfolio visualizer, which only takes into account returns in the last 30 years, the best year differs by 16.7% vs 13.6% and the worst year by -6.23% vs -7.4%. For the bond portion of a portfolio, I could see this make a difference in simulated historical returns.

For a back of the napkin calculation maybe it doesn't matter, and we all know these are guesses anyways, but a lot of us like to use these calculators to figure out what gives us, say, a historical 95% chance of success. I'm trying to see how FIREcalc numbers could be modified for a high tax-bracket retiree who has a large taxable account. I can reduce available spending (or add to spending) by taxing dividends any capital gains from sold assets, but I'm not sure that using treasury bond returns and taxing interest at income tax rates would return the same numbers as muni bond returns without taxes.
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grabiner
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Re: Historical muni bond returns for retirement calculators

Post by grabiner »

travis_nyc wrote: Fri Sep 16, 2022 7:34 pm Maybe I'm misunderstanding, but when I compare similar duration municipal bonds with treasury bonds in PortfolioVisualizer, I get wildly different returns. For example, in 2008, muni bonds had a negative return and treasury bonds had a positive return, vice versa in 2009, and in 2010 treasury bonds outperformed munis significantly, while munis outperformed in 2011. This is all before considering taxes. Over the long term, the treasury bonds outperform the munis, which you would expect because taxes aren't being taken into account.
There are two issues here.

Munis have credit risk, while Treasuries don't, which is why Treasuries outperform munis as default risk increased in 2008.

Also, duration is not quite equivalent, because most munis are callable, and thus their duration increases as rates increase. Two years ago, Vanguard Long-Term Tax-Exempt had a 5-year duration; it now has a 7-year duration. This negative convexity causes muni funds to lose more than other bond funds of the same duration when rates rise significantly, and gain less when rates fall significantly.
Wiki David Grabiner
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