should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

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Case
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should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by Case »

The bond composition of my portfolio is in VBTLX (total bond market fund). However, I store this fund in my taxable account rather than tax-free accounts. I do this because I want to maximize long term portfolio value rather than simply reduce overall taxes. This concept has been discussed here before on this forum a few times.***

SO, my question is:
Since my bonds are in taxable accounts, would I be better off switching them to a tax-exempt bond fund (e.g. muni bond fund)? Generally, muni bond funds are more volatile than VBTLX, which is one trade off. But perhaps this warrants the tax advantages of VWIUX? VWIUX does not appear to be a terribly risky muni bond fund, so this idea wouldn't be as crazy as some of the other high-yield muni bond funds out there.

At this point, my VBTLX is down so I would harvesting tax losses (e.g. no capital gains to worry about).



*** (Generally speaking, i believe it is better to have your stocks in tax-free accounts rather than bonds, because this maximizes their long term growth potential, which tends to outweight the benefits of storing bonds (tax inefficient) in a tax free account. This is counter to a lot of common investing trends here, but I believe this forum has sometimes come to the consensus that it is overall better).
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by flamesabers »

What tax bracket are you in? I think that's a major factor as to which bond fund is more suited to you.
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by dspencer »

flamesabers wrote:What tax bracket are you in? I think that's a major factor as to which bond fund is more suited to you.
Vanguard even has a tool to make it easier:

https://personal.vanguard.com/us/funds/ ... alentyield
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by PFInterest »

Depends on your bracket.
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Case
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by Case »

flamesabers wrote:What tax bracket are you in? I think that's a major factor as to which bond fund is more suited to you.
28%
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by flamesabers »

Case wrote:
flamesabers wrote:What tax bracket are you in? I think that's a major factor as to which bond fund is more suited to you.
28%
Using the Vanguard tool dspencer linked, a taxable equivalent yield for VWIUX at your tax bracket is 2.76%. Since the current yield for VBTLX is 2.41%, it looks like you're better off going with a tax-exempt muni bond fund.
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by grabiner »

Case wrote:
flamesabers wrote:What tax bracket are you in? I think that's a major factor as to which bond fund is more suited to you.
28%
My rule of thumb is that munis are priced to break even with corporate bonds of comparable risk in a 25% bracket, so at 28%, there is a small advantage for munis (and a larger advantage if Vanguard has a fund for your state).
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by dratkinson »

The short answer. Until you've conducted your own due diligence, VWIUX is a recommended safe place to start.


The long answer.

The safest advice is to use an IT (intermediate term) national muni fund. But as you are comfortable "shooting for the moon" in your tax-advantaged space, can do the same in your taxable space by using a LT (long-term) national muni for more risk/return; Vanguard's is VWLUX.


Total return. The major component of a bond fund's total return (price appreciation + dividends) is dividends. So within reason, I prefer more dividends to less, so prefer VWLUX to VWIUX. (I own both. As I'm not planning to sell anytime soon, I don't worry about VWLUX's NAV fluctuations. And if I do need to sell during an emergency, I'll start with VWIUX.)


Recommended book. Search Wiki for list of recommended "books" (search term) and read the bond book by Swedroe. Pay particular attention to the chapter on municipal bonds. Until you get your book, can read the Wiki topic on municipal bonds.


"Daily accrual" muni funds. Search Wiki for "tax loss harvesting" topic and note the special handling of "daily accrual" muni funds; they are exempt from the IRS 6-mo holding period requirement to protect tax-exempt dividends. This means a daily accrual muni can do double duty: (1) as a part of your bond allocation, and (2) as a tier of your emergency funds.

Both VWIUX and VWLUX are daily accrual funds.


Single-state muni fund. If Vanguard has one for your state, the recommendation is to split your muni bond allocation 50/50 national/single-state.

If Vanguard does not have one for your state, then can use the advice in Swedroe's book/forum/blog posts for how his firm chooses individual muni bonds, to search for a suitable fund from another provider. (Can search forum for "WTCOX" for how I did this for myself.)


Student exercises to perform your own due diligence.

Search internet for current SEC yields, duration, and 52-week price spreads on: VBTLX, VWIUX, VWLUX. Why? Recall Swedroe's advice is that we should expect ~25 basis points more yield/yr (taxable-equivalent yield, to account for our tax situation), for each year of additional duration. Use this information to see if you can handle VWLUX's price fluctuations, and if it would adequately compensate you for its additional duration.
Example: if 5-yr duration VBTLX's SEC yield is 2%, than a 7-yr duration national muni needs a TEY of: 2.5% = 2% + (2x.25%).

Search internet for single-state muni fund candidates. Though I never found a reference saying so, I extended above advice to require 25 basis points more yield/yr (TEY, to account for our tax situation), for each year of duration, as adequate compensation for the additional risk of a single-state fund.
Example: if 5-yr duration VBTLX's SEC yield is 2%, than a 7-yr duration single-state muni needs a TEY of: 3.75% = 2% + (7x.25%).

These exercises are to help you begin thinking about the process of performing your own due diligence in searching for a suitable VBTLX replacement. But they are not all-inclusive. Why?


Evaluating a prospectus. Because there are some scary (loads, high fees, junk bonds, AMT exposure,...) muni fund prospectuses out there that make Vanguard's HY muni look tame by comparison. So learning to evaluate a prospectus* is a required part of your due diligence.

* Don't remember where I found this information (book, forum, Wiki, internet blog?). The short answer: most of what you need to quickly evaluate a prospectus (less than 5 minutes) and place it in the "discard" or "more thought required" piles is contained in the "investing objectives" and "fees" sections.


Bottom line. At the end of your due diligence, you'll have done your own research and can quote chapter and verse why your muni selection is appropriate for you.


But until you've conducted your own due diligence, VWIUX is a recommended safe place to start.
d.r.a., not dr.a. | I'm a novice investor, you are forewarned.
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Case
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by Case »

dratkinson wrote:The short answer. Until you've conducted your own due diligence, VWIUX is a recommended safe place to start.


The long answer.

The safest advice is to use an IT (intermediate term) national muni fund. But as you are comfortable "shooting for the moon" in your tax-advantaged space, can do the same in your taxable space by using a LT (long-term) national muni for more risk/return; Vanguard's is VWLUX.


Total return. The major component of a bond fund's total return (price appreciation + dividends) is dividends. So within reason, I prefer more dividends to less, so prefer VWLUX to VWIUX. (I own both. As I'm not planning to sell anytime soon, I don't worry about VWLUX's NAV fluctuations. And if I do need to sell during an emergency, I'll start with VWIUX.)


Recommended book. Search Wiki for list of recommended "books" (search term) and read the bond book by Swedroe. Pay particular attention to the chapter on municipal bonds. Until you get your book, can read the Wiki topic on municipal bonds.


"Daily accrual" muni funds. Search Wiki for "tax loss harvesting" topic and note the special handling of "daily accrual" muni funds; they are exempt from the IRS 6-mo holding period requirement to protect tax-exempt dividends. This means a daily accrual muni can do double duty: (1) as a part of your bond allocation, and (2) as a tier of your emergency funds.

Both VWIUX and VWLUX are daily accrual funds.


Single-state muni fund. If Vanguard has one for your state, the recommendation is to split your muni bond allocation 50/50 national/single-state.

If Vanguard does not have one for your state, then can use the advice in Swedroe's book/forum/blog posts for how his firm chooses individual muni bonds, to search for a suitable fund from another provider. (Can search forum for "WTCOX" for how I did this for myself.)


Student exercises to perform your own due diligence.

Search internet for current SEC yields, duration, and 52-week price spreads on: VBTLX, VWIUX, VWLUX. Why? Recall Swedroe's advice is that we should expect ~25 basis points more yield/yr (taxable-equivalent yield, to account for our tax situation), for each year of additional duration. Use this information to see if you can handle VWLUX's price fluctuations, and if it would adequately compensate you for its additional duration.
Example: if 5-yr duration VBTLX's SEC yield is 2%, than a 7-yr duration national muni needs a TEY of: 2.5% = 2% + (2x.25%).

Search internet for single-state muni fund candidates. Though I never found a reference saying so, I extended above advice to require 25 basis points more yield/yr (TEY, to account for our tax situation), for each year of duration, as adequate compensation for the additional risk of a single-state fund.
Example: if 5-yr duration VBTLX's SEC yield is 2%, than a 7-yr duration single-state muni needs a TEY of: 3.75% = 2% + (7x.25%).

These exercises are to help you begin thinking about the process of performing your own due diligence in searching for a suitable VBTLX replacement. But they are not all-inclusive. Why?


Evaluating a prospectus. Because there are some scary (loads, high fees, junk bonds, AMT exposure,...) muni fund prospectuses out there that make Vanguard's HY muni look tame by comparison. So learning to evaluate a prospectus* is a required part of your due diligence.

* Don't remember where I found this information (book, forum, Wiki, internet blog?). The short answer: most of what you need to quickly evaluate a prospectus (less than 5 minutes) and place it in the "discard" or "more thought required" piles is contained in the "investing objectives" and "fees" sections.


Bottom line. At the end of your due diligence, you'll have done your own research and can quote chapter and verse why your muni selection is appropriate for you.


But until you've conducted your own due diligence, VWIUX is a recommended safe place to start.
Thank you for the super detailed answer!
This is going to take some time to process, but I will look into it.

I guess what I'm looking for is:
Using muni funds, is there a way to maintain the same overall risk-reward ratio of your portfolio but operate more tax efficiently?
For example, maybe the muni fund is a little more volatile than VBTLX, so I increase my overall bond/stock ratio, but now have the bonds in a more tax efficient vehicle?
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by grabiner »

Case wrote:I guess what I'm looking for is:
Using muni funds, is there a way to maintain the same overall risk-reward ratio of your portfolio but operate more tax efficiently?
For example, maybe the muni fund is a little more volatile than VBTLX, so I increase my overall bond/stock ratio, but now have the bonds in a more tax efficient vehicle?
My rule of thumb is that a taxable bond fund has the same risk as a muni fund with 75% of the yield; that is, the decision would be break-even in a 25% bracket.

Currently, Total Bond Market Admiral shares yield 2.42%, which would be 1.82% after-tax in a 25% bracket. Intermediate-Term Tax-Exempt Admiral shares yield 1.99%. Thus the two are relatively close in risk, and you would use either one the same way.

For comparison, Long-Term Tax-Exempt Admiral shares yield 2.51%; you can use this as your core bond fund, but you would have a somewhat riskier portfolio unless you also increase your bond holdings.
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by dratkinson »

I don't have the background to give a more exact answer. So I must look for simple, easy to follow "actions steps" that are "good enough" to make a decision.

In this case:
--VBTLX and VWIUX are both IT funds and recommended by the forum where appropriate.
--VWIUX's use in the 28% fed tax bracket is "appropriate" due to TEY.
--Mr Bogle likes corporate bonds.
--BH-recommended authors say munis are safer than corporate bonds.
--Mortgage backed securities are deprecated: low-side risk, no corresponding high-side benefit.
--VBTXL is ~1/3 each: treasuries, MBS, corporate. Meaning VWIUX is preferable to 2/3 for VBTLX.

So my simple action step becomes, "if VWIUX is preferable to 2/3 of VBTLX, and it has a better TEY, then use it". For me this must be "good enough" to make a decision.



By three methods we may learn wisdom:
First, by reflection, which is noblest;
Second, by imitation, which is easiest;
and third by experience, which is the bitterest.
--Confucius

I believe the use of VWIUX is a no-brainer in your case. Why? Because the recommended authors have already done the required due diligence. So in this you are simply imitating what they have done.

But if you want to reach for additional return/risk (longer duration, single-state muni,...), you'll need to make, and live with, that decision for yourself. That's where it's required that you learn to do your own due diligence; so you learn to identify risks, and whether you want to avoid them or accept them. Think: Worldcomm, Enron, Bernie Madoff,....



Forum advice: Where recommended author's agree, that is the central course; where they disagree, those are optional routes.

VWIUX is on the central course. Your due diligence is required before taking an optional route.



Forum advice: Plan for the worst, hope for the best.

Example. If you decide to go the muni route and want to use them as a tier of your EF, but worry that their volatility might cause them to dip below a fixed dollar amount... what do you do? You can over fund your muni allocation. How much?

During a crash, bonds can lose 5-15% of their value, so if you need 100% of a fixed value for an EF tier, then fund them to 118% (=1/(1-.15)). Then if the worst happens, you'll still have the 100% fixed value in your EF.

So if your investing game plan is to use munis as an EF tier, your due diligence might require you to over fund them as a contingency to handle a worst-case bond crash.



Forum advice: Create an Investment Policy Statement (IPS).

Search Wiki for IPS. Create one for yourself. Why? After you do all of the work (your due diligence) to come up with an investing game plan, an IPS is your insurance that you will not forget it.

An IPS is a living document. Update it as your investing situation changes and as you learn more.

Refer to your IPS often to remind you what you are doing and why.
d.r.a., not dr.a. | I'm a novice investor, you are forewarned.
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Case
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by Case »

dratkinson wrote:I don't have the background to give a more exact answer. So I must look for simple, easy to follow "actions steps" that are "good enough" to make a decision.

In this case:
--VBTLX and VWIUX are both IT funds and recommended by the forum where appropriate.
--VWIUX's use in the 28% fed tax bracket is "appropriate" due to TEY.
--Mr Bogle likes corporate bonds.
--BH-recommended authors say munis are safer than corporate bonds.
--Mortgage backed securities are deprecated: low-side risk, no corresponding high-side benefit.
--VBTXL is ~1/3 each: treasuries, MBS, corporate. Meaning VWIUX is preferable to 2/3 for VBTLX.

So my simple action step becomes, "if VWIUX is preferable to 2/3 of VBTLX, and it has a better TEY, then use it". For me this must be "good enough" to make a decision.



By three methods we may learn wisdom:
First, by reflection, which is noblest;
Second, by imitation, which is easiest;
and third by experience, which is the bitterest.
--Confucius

I believe the use of VWIUX is a no-brainer in your case. Why? Because the recommended authors have already done the required due diligence. So in this you are simply imitating what they have done.

But if you want to reach for additional return/risk (longer duration, single-state muni,...), you'll need to make, and live with, that decision for yourself. That's where it's required that you learn to do your own due diligence; so you learn to identify risks, and whether you want to avoid them or accept them. Think: Worldcomm, Enron, Bernie Madoff,....



Forum advice: Where recommended author's agree, that is the central course; where they disagree, those are optional routes.

VWIUX is on the central course. Your due diligence is required before taking an optional route.



Forum advice: Plan for the worst, hope for the best.

Example. If you decide to go the muni route and want to use them as a tier of your EF, but worry that their volatility might cause them to dip below a fixed dollar amount... what do you do? You can over fund your muni allocation. How much?

During a crash, bonds can lose 5-15% of their value, so if you need 100% of a fixed value for an EF tier, then fund them to 118% (=1/(1-.15)). Then if the worst happens, you'll still have the 100% fixed value in your EF.

So if your investing game plan is to use munis as an EF tier, your due diligence might require you to over fund them as a contingency to handle a worst-case bond crash.



Forum advice: Create an Investment Policy Statement (IPS).

Search Wiki for IPS. Create one for yourself. Why? After you do all of the work (your due diligence) to come up with an investing game plan, an IPS is your insurance that you will not forget it.

An IPS is a living document. Update it as your investing situation changes and as you learn more.

Refer to your IPS often to remind you what you are doing and why.
Alright, I think I'm following you. I will check out Swedroe's book. VWIUX sounds like a good option. I will work on firming up my IPS, in order to better define the target bond/stock percentages I need for my investing goals. And then using that, determine if VWLUX is appropriate.

Now, to throw another cog in the works, consider that I am aiming to retire in 5-10 years. At that point, I will fall from the 28% (or possibly 33% bracket near the end) down to a very low bracket. At this stage, VBTLX will probably be a better fit. But I wouldn't necessarily want to sell all my bond funds and repurchase VBTLX, due to triggering capital gains (though the effects of this are not so severe for the bond portion of the portfolio... and the shares might even be down, making it a moot point, as is the case now).

In terms of EF, I currently have cash, had not considered using the muni's (or bonds) for that purpose, but could consider that.
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Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by dratkinson »

Case wrote:
dratkinson wrote:...

Now, to throw another cog in the works, consider that I am aiming to retire in 5-10 years. At that point, I will fall from the 28% (or possibly 33% bracket near the end) down to a very low bracket. At this stage, VBTLX will probably be a better fit. But I wouldn't necessarily want to sell all my bond funds and repurchase VBTLX, due to triggering capital gains (though the effects of this are not so severe for the bond portion of the portfolio... and the shares might even be down, making it a moot point, as is the case now).

In terms of EF, I currently have cash, had not considered using the muni's (or bonds) for that purpose, but could consider that.

After I had quit working (no earned income) and was in the 15% fed tax bracket before taking SS, had my forum review, had read the Swedroe and Thau bond book (looking for the central course and optional routes), and done my due diligence surrounding muni funds.... I understood...

VWIUX produces a slightly lower TEY than VBTLX in the 15% fed tax bracket, but a better TEY in the 25%+ fed tax brackets.
VWLUX produces a slightly better TEY than VBTLX in the 15%+ fed tax brackets.

I foresaw the day when I would take SS and be pushed into a higher tax bracket. So while in the 15% tax bracket and before SS, I planned my bond allocation for then (my worse case).

So I started with a small allocation to VWITX (recall TEY may have been slightly better than TBM back then, don't remember), and added VWLTX as I became comfortable with munis. I quickly learned that I preferred VWLTX (higher dividends) so skewed new contributions to it.

A few years later I entered the 25% tax bracket due to taxable account stock fund dividends. Thought muni TE dividends do not add to AGI, QDI/LTCG (even when taxed at 0%) do add to AGI which does push one into a higher tax bracket.


After-tax income analysis. To help me analyze after-tax income scenarios, I used excel1040.com.
--Enter last fed tax return to create a known baseline.
--Then enter different bond fund scenarios. Wag bond scenario dividends as: total annual bond dividends = total bond principle x SEC yield.
--My state tax is a flat tax system with a few additions/subtractions, so easy to replicate in Excel.
--After-tax income: total income - fed tax - state tax. (Don't forget to add back muni dividends as they don't appear in 1040 total income.)

I added two new sheets to excel1040.com and did all of my work there, so it was easy to keep everything together. One sheet analyzed ~10 bond fund scenarios (TBM, treasuries ST/IT/LT, corporate ST/IT/LT, munis ST/IT/LT) before taking SS. The second sheet did the same after taking SS.


Today I'm in the bottom of the 25% tax bracket, have a small allocate to VWIUX (the last/largest tier of my formal EFs, home project/new car fund, and dry powder), a large allocation to VWLUX, and a growing allocation to a single-state muni.


My due diligence says I'm doing the best I can for myself. My bond allocation was set up back then with an eye to the future, so I could "shoot for the moon" in my small tax-advantaged space.


Simple actions steps.
--Read a few bond books. Identify the central course (where authors agree). Identify optional routes (where authors disagree).
--Conduct an after-tax income analysis: current, after retirement but before taking SS, after taking SS.

I can't suggest any method better than this to help you think about how to set yourself up for the future.


Exception: while in the 15% fed tax bracket, that would be a good time to convert any tax-deferred accounts to a Roth IRA. Your work with excel1040.com can help you identify how much annual tax bracket headroom you can expect to have for the conversions.

Exception: If important, pay attention to tax-bracket Obamacare subsidies. I never played with that so can offer no suggestions.
d.r.a., not dr.a. | I'm a novice investor, you are forewarned.
Topic Author
Case
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Joined: Sun Jan 03, 2016 6:41 pm

Re: should i switch my VBTLX into VWIUX (e.g. muni bond fund)? [in taxable]

Post by Case »

dratkinson wrote:
Case wrote:
dratkinson wrote:...

Now, to throw another cog in the works, consider that I am aiming to retire in 5-10 years. At that point, I will fall from the 28% (or possibly 33% bracket near the end) down to a very low bracket. At this stage, VBTLX will probably be a better fit. But I wouldn't necessarily want to sell all my bond funds and repurchase VBTLX, due to triggering capital gains (though the effects of this are not so severe for the bond portion of the portfolio... and the shares might even be down, making it a moot point, as is the case now).

In terms of EF, I currently have cash, had not considered using the muni's (or bonds) for that purpose, but could consider that.

After I had quit working (no earned income) and was in the 15% fed tax bracket before taking SS, had my forum review, had read the Swedroe and Thau bond book (looking for the central course and optional routes), and done my due diligence surrounding muni funds.... I understood...

VWIUX produces a slightly lower TEY than VBTLX in the 15% fed tax bracket, but a better TEY in the 25%+ fed tax brackets.
VWLUX produces a slightly better TEY than VBTLX in the 15%+ fed tax brackets.

I foresaw the day when I would take SS and be pushed into a higher tax bracket. So while in the 15% tax bracket and before SS, I planned my bond allocation for then (my worse case).

So I started with a small allocation to VWITX (recall TEY may have been slightly better than TBM back then, don't remember), and added VWLTX as I became comfortable with munis. I quickly learned that I preferred VWLTX (higher dividends) so skewed new contributions to it.

A few years later I entered the 25% tax bracket due to taxable account stock fund dividends. Thought muni TE dividends do not add to AGI, QDI/LTCG (even when taxed at 0%) do add to AGI which does push one into a higher tax bracket.


After-tax income analysis. To help me analyze after-tax income scenarios, I used excel1040.com.
--Enter last fed tax return to create a known baseline.
--Then enter different bond fund scenarios. Wag bond scenario dividends as: total annual bond dividends = total bond principle x SEC yield.
--My state tax is a flat tax system with a few additions/subtractions, so easy to replicate in Excel.
--After-tax income: total income - fed tax - state tax. (Don't forget to add back muni dividends as they don't appear in 1040 total income.)

I added two new sheets to excel1040.com and did all of my work there, so it was easy to keep everything together. One sheet analyzed ~10 bond fund scenarios (TBM, treasuries ST/IT/LT, corporate ST/IT/LT, munis ST/IT/LT) before taking SS. The second sheet did the same after taking SS.


Today I'm in the bottom of the 25% tax bracket, have a small allocate to VWIUX (the last/largest tier of my formal EFs, home project/new car fund, and dry powder), a large allocation to VWLUX, and a growing allocation to a single-state muni.


My due diligence says I'm doing the best I can for myself. My bond allocation was set up back then with an eye to the future, so I could "shoot for the moon" in my small tax-advantaged space.


Simple actions steps.
--Read a few bond books. Identify the central course (where authors agree). Identify optional routes (where authors disagree).
--Conduct an after-tax income analysis: current, after retirement but before taking SS, after taking SS.

I can't suggest any method better than this to help you think about how to set yourself up for the future.


Exception: while in the 15% fed tax bracket, that would be a good time to convert any tax-deferred accounts to a Roth IRA. Your work with excel1040.com can help you identify how much annual tax bracket headroom you can expect to have for the conversions.

Exception: If important, pay attention to tax-bracket Obamacare subsidies. I never played with that so can offer no suggestions.
Thanks again for the detailed advice <bows to the bond guru>!

I have a lot of work/reading ahead of me..
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