Using Extended Treasury (EDV) for tax efficiency

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sycojason
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Using Extended Treasury (EDV) for tax efficiency

Post by sycojason » Mon Aug 01, 2011 10:36 pm

Hey Bogleheads!

I recently learned that bond funds are tax-inefficient and that the longer the duration, the more taxes it incures over a portfolio's lifetime. And thus it is better to hold them in tax-advantaged accounts (IRA or 401K) if someone is interested in optimal fund placement.

I want to use long term treausury ETF (VGLT) as my bond position but was discouraged with the tax consequences holding it in taxable account.

So here's my idea for fund placement that would give it a more tax-efficient bond holding. I thought of mixing short term treasury (VGSH) and extended treasury treasury (EDV) to generate returns similar to VGLT. And I found the % allocation to be 70% EDV and 30% VGSH with some backtesting.

(The down side is that since the ETFs have only been launched 2 years ago, there isn't too much data available on yahoo! finance.)

So I can now place as the tax-inefficient EDV in my IRA and hold VGSH in my taxable account and still get similar returns and have lower taxable distributions.

How does that sound to you folks?

J. Co

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fredflinstone
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Post by fredflinstone » Tue Aug 02, 2011 11:10 am

very interesting. I don't know the answer, but am interested to hear what others think.

staythecourse
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Post by staythecourse » Tue Aug 02, 2011 11:44 am

I think that is reasonable. I would just get the durations of each fund you are thinking about and do the calculations to get the same duration your wish vs. backtesting past data.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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wintermute
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Post by wintermute » Tue Aug 02, 2011 8:03 pm

That's an awful lot of LT treasuries. If you want to approximate IT, you can do the barbell split you're talking about. You'll gain convexity but loose a little yield.

See Grok's Tip #9:
http://www.bogleheads.org/forum/viewtopic.php?t=73669

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Noobvestor
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Post by Noobvestor » Tue Aug 02, 2011 9:27 pm

Just make sure you're serious about this and not market timing EDV is up 10% in the last week :S

That said, there are some good debates around here involving folks like RobertT and SmallHi on the duration issue and barbelling (long and short). I think the consensus is that there's no really compelling reason *not* to barbell, but that you don't gain a lot by doing it except perhaps in cases like yours where there is a tax efficiency issue in play.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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tarnation
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Post by tarnation » Tue Aug 02, 2011 9:29 pm

a couple of points to consider,
To match the yield of VGLT, I get 90% EDV; to match the maturity I get 86% EDV. So you might double check your numbers.

Also, the spread on EDV is usually not the greatest and always at a premium.

Lastly, if you are going to barbell, then on the short side you could use VCSH.
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xerty24
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Re: Using Extended Treasury (EDV) for tax efficiency

Post by xerty24 » Tue Aug 02, 2011 10:01 pm

sycojason wrote:I recently learned that bond funds are tax-inefficient and that the longer the duration, the more taxes it incures over a portfolio's lifetime.
Perhaps you don't understand the tax treatment. All taxable bonds have the basic treatment - interest is taxed every year, whether it's paid to you or not. So it doesn't matter if you earn $1 of interest on a 2 year bond or a 20 year bond, you pay the same taxes this year. Now a longer bond will likely have a higher interest rate (hence pay more taxes due to earning more money), but it is also more risky. The former argues for long term bonds in an IRA, while the latter argues for them in taxable for loss harvesting from the volatility.

If tax-advantaged space is at a premium motivating the split you describe between short and long in taxable and IRA, you will also have a problem with rebalancing. For your barbell to work, you'll want to rebalance and that's not as easy since you can't move money freely into or out of your IRA accounts.

grok87
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Post by grok87 » Wed Aug 03, 2011 7:11 pm

wintermute wrote:That's an awful lot of LT treasuries. If you want to approximate IT, you can do the barbell split you're talking about. You'll gain convexity but loose a little yield.

See Grok's Tip #9:
http://www.bogleheads.org/forum/viewtopic.php?t=73669
I recommend using a FDIC insured savings account yielding 1% for the cash portion of the barbell
Cheers
Keep calm and Boglehead on. KCBO.

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