Alternatives to muni bonds? (and portfolio update)

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noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Sat Apr 07, 2018 11:30 am

I wanted to do an update and check-in after my first post last year [viewtopic.php?f=1&t=208855&p=3204427].
We implemented the extremely helpful advice you all provided last year (still working on parts of it) including one fund per account, moving AA to more bonds, etc. I had a question on fixed income that I could use some help on.

Thanks in advance for any help/thoughts you can provide!

Emergency fund: 6+ months
Debt: Mortgage – Primary $550k @ 3.1% (7/1ARM), Rental $400k @ 4.1% (30FRM)
Tax Filing Status: Married filing jointly
Tax Rate: 35% Federal (not sure for this year?), 9.3% CA
Ages: late 30s/early 40s
Asset allocation: 70% stocks/ 30% bonds (Intl: 25%)
Current assets $3M+ with Current AA: 52% US/ 17% Intl/ 26% Bond/ 5% Cash or CDs

Her 401k:
7% Fidelity® U.S. Bond Index Fund (FXNAX) (.03)

Her Roth 401k:
2% Fidelity US EQ INDX CL 2 (no ticker but targeted to total US stock index) (.013)

Her Roth IRA:
5% Vanguard Total Stock Mkt Idx (VTSAX) (.05)

Her NQ Deferred Comp:
4% Fidelity® 500 Index Fund (FUSVX) (.035)

His 401k:
8% Vanguard Total Bond Market Index (VBTLX) (.05)

His Roth IRA:
3% Vanguard Total Stock Mkt Idx (VTSAX) (.05)

Taxable: 71% 
33% Vanguard Total Stock Mkt Idx (VTSAX) (.05) plus other total stock approximations
17% Vanguard Total Intl Stock Index (VTIAX) (.11) plus other total intl stock approximations
4% Vanguard Interm-Term Tx-Ex (VWIUX) (.09)
4% Vanguard Interm-Term CA Tx-Ex (VCADX) (.09)
3% Vanguard Long-Term Tx-Ex (VWLUX) (.09)
4% various company stocks -- Plan to sell but need time to deal with cap gains/DAF
5% cash/CDs

Retirement Plan:
Retire in 5 years with ~$3.5M investments and fully paid home
Asset Allocation: 60% stock/ 40% bonds (planning for more stock due to early retirement)
Mortgage: Pay off primary mortgage before 7/1 ARM ends
Expenses: $100k annually (includes $30k for healthcare and ability to trim some fat if needed)
Rental: Keep rental as long as cash flow positive

Questions:
1. I have $100k+ that I need to shift from individual stocks and cash to fixed income in my taxable account. I already have 11% of my portfolio in muni bonds (I've read here that you don't want to put too much in muni bonds) but I don't know what some good options in taxable are: more total bond market, more muni, treasury bills, I-bonds, CDs or something else?
2. Anything I should change/consider with my investments now or in preparation for retirement? Perhaps move more to CDs.

goingup
Posts: 3045
Joined: Tue Jan 26, 2010 1:02 pm

Re: Alternatives to muni bonds? (and portfolio update)

Post by goingup » Sat Apr 07, 2018 11:50 am

Nice streamlined portfolio. Congratulations on implementation!

Our situation is similar, though we're a bit older. I don't think having 11% muni fund is a problem. Alan Roth suggests no more than 20% of bond portfolio in munis. https://blog.aarp.org/2015/07/14/4-reas ... uni-bonds/

Places for your $100K could be Vanguard's Limited Term Munis, or even a MM fund. You may consider paying off your mortgage sooner if there's no longer a tax benefit. A CD ladder may be something to consider, though it will throw off interest income. It's a small part of your portfolio so I wouldn't sweat it too much.

Marketman
Posts: 196
Joined: Sun Feb 04, 2018 2:24 pm
Location: Texas

Re: Alternatives to muni bonds? (and portfolio update)

Post by Marketman » Sat Apr 07, 2018 1:43 pm

I agree that you could use more munis if you wanted. I also agree that paying down the mortgage is never a bad decision. Depending which state you live in, Treasury Bonds (or I-Bonds) might make good sense as their interest is exempt from state taxes.

noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Sun Apr 08, 2018 2:45 pm

goingup wrote:
Sat Apr 07, 2018 11:50 am
Nice streamlined portfolio. Congratulations on implementation!

Our situation is similar, though we're a bit older. I don't think having 11% muni fund is a problem. Alan Roth suggests no more than 20% of bond portfolio in munis. https://blog.aarp.org/2015/07/14/4-reas ... uni-bonds/

Places for your $100K could be Vanguard's Limited Term Munis, or even a MM fund. You may consider paying off your mortgage sooner if there's no longer a tax benefit. A CD ladder may be something to consider, though it will throw off interest income. It's a small part of your portfolio so I wouldn't sweat it too much.
Thanks goingup!
I can't wait to get to a point with our portfolio where I can just leave it be.

The Allan Roth article is interesting but is it of your total portfolio or just the fixed income portion? Of my fixed income portfolio, muni bonds are currently 30%+. I read it somewhere here that it was recommended to have no more than 10% of your total portfolio in munis but maybe it wasn't consensus. I might add it to my CA Interm-Term to get to 50% State/50% Federal.

As for VG Limited Term Muni, I was using that as a tax loss harvesting pairing. I'm just starting out with TLH so trying to keep it simple for me.

For the mortgage, we still have a tax benefit under the new TCJA so plan to keep it until post-retirement and the ARM expires.

noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Sun Apr 08, 2018 3:09 pm

Marketman wrote:
Sat Apr 07, 2018 1:43 pm
I agree that you could use more munis if you wanted. I also agree that paying down the mortgage is never a bad decision. Depending which state you live in, Treasury Bonds (or I-Bonds) might make good sense as their interest is exempt from state taxes.
Thanks Marketman. I'm in CA so the tax rates are quite high.

I'll confess that I've tried reading about Treasury bonds a few times but still haven't figured out why and if I need them in my portfolio, for less risk I suppose.

For I-Bonds, it doesn't seem like there's a way to get more than $20k/year though (there are 2 of us). But I suppose if we build it up over the years, it might become a bigger part of the portfolio. Or after reading this (https://www.bogleheads.org/wiki/I_Bonds_vs_TIPS) maybe TIPS instead so I could buy it all at once.

ofckrupke
Posts: 461
Joined: Mon Jan 10, 2011 2:26 pm

Re: Alternatives to muni bonds? (and portfolio update)

Post by ofckrupke » Sun Apr 08, 2018 5:58 pm

Two small points:

If one is splitting CA and national muni funds to reduce risk and targeting an overall intermediate duration, it's more tax efficient to split as short-term national plus long-term CA. (I get the impression the OP's holdings might have hewn closer to this approach prior to recent TLH.)

In the OP's tax brackets, as long as TISM is distributing ~1% more dividends annually than TSM (and almost all of that difference in non-qualified form!), lower tax drag is achieved by holding the TISM in tax-advantaged accounts. About 0.48% (0.44% +0.038 for NIIT) for the difference in dividend vs. ~0.20% FTC (7% x ~2.9%), so a bit more than a quarter percent per year, neglecting effects due to disparities in fund costs across the various accounts. Of course, the tax cost for the OP to shuffle existing holdings might be far greater, but something to think about for new money...

goingup
Posts: 3045
Joined: Tue Jan 26, 2010 1:02 pm

Re: Alternatives to muni bonds? (and portfolio update)

Post by goingup » Mon Apr 09, 2018 9:49 am

noobogle wrote:
Sun Apr 08, 2018 2:45 pm
goingup wrote:
Sat Apr 07, 2018 11:50 am
Nice streamlined portfolio. Congratulations on implementation!

Our situation is similar, though we're a bit older. I don't think having 11% muni fund is a problem. Alan Roth suggests no more than 20% of bond portfolio in munis. https://blog.aarp.org/2015/07/14/4-reas ... uni-bonds/

Places for your $100K could be Vanguard's Limited Term Munis, or even a MM fund. You may consider paying off your mortgage sooner if there's no longer a tax benefit. A CD ladder may be something to consider, though it will throw off interest income. It's a small part of your portfolio so I wouldn't sweat it too much.
Thanks goingup!
I can't wait to get to a point with our portfolio where I can just leave it be. Yes, I think Bill Bernstein says a portfolio is like a bar of soap, the more you handle it, the less there is to use.

The Allan Roth article is interesting but is it of your total portfolio or just the fixed income portion? I think he's talking about percentages of the fixed income part of a portfolio, unless I'm reading it wrong.

Valuethinker
Posts: 34680
Joined: Fri May 11, 2007 11:07 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by Valuethinker » Mon Apr 09, 2018 11:30 am

noobogle wrote:
Sun Apr 08, 2018 3:09 pm
Marketman wrote:
Sat Apr 07, 2018 1:43 pm
I agree that you could use more munis if you wanted. I also agree that paying down the mortgage is never a bad decision. Depending which state you live in, Treasury Bonds (or I-Bonds) might make good sense as their interest is exempt from state taxes.
Thanks Marketman. I'm in CA so the tax rates are quite high.

I'll confess that I've tried reading about Treasury bonds a few times but still haven't figured out why and if I need them in my portfolio, for less risk I suppose.
1. less risk. They are assumed to be of no credit risk. If a default resulted for political reasons, unless it was swiftly reversed, then all heck would break loose in world financial markets. I normally revel in gloom-and-doom scenarios but that one tests even me... I assume good sense on the part of US politicians (I know, I know, but this is trillions of dollars of securities and core to financial markets that we are talking about ...)

2. in the case of deflation & lower future interest rates, they are the best protection. David Swensen spends a lot of time on this but, basically:

- US mortgage backed securities (Agency issued) are credit risk free but have extension/ prepayment risk-- basically duration (interest rate sensitivity) goes against you (changes)

- corporate bonds are often callable (and have credit risk, which is bad) - so if interest rates drop, the issuer will simply call the bonds and you lose the lock in of a higher yield that was available when you bought

- US Treasury bonds will simply hold to maturity, so your coupon and redemption are worth more. For a fund, the price/ NAV will probably go up

- I am not US based, but as I understand it, you don't pay state tax on the interest on US Treasury Bonds? (don't take my word for it)

Thus US Treasury bonds are the ultimate "plain vanilla" form of bond investing. This, I think, is why Larry Swedroe and David Swensen recommend them. UST bond funds behave in the same ways, except the duration is more or less constant-- whereas with individual bonds, the duration drops as the bonds move closer to maturity.

Municipal bonds may be preferred if they give you a higher after tax return. In the case of CA, my understanding is the fiscal position is quite strong, at least until the next recession/ tech crash. If we were talking about Illinois, I would urge real caution.

Note to be clear, one should not own individual municipal bonds. That only works if you have experience as a credit analyst-- and even they get it wrong. Different bonds, even issued by the same entity, have different rights as to security & repayment. For example project-related bonds generally (as I understand it) have higher default rates if they are only going to be repaid by the cash flows of the project, not by General Obligation on the taxpayer.
For I-Bonds, it doesn't seem like there's a way to get more than $20k/year though (there are 2 of us). But I suppose if we build it up over the years, it might become a bigger part of the portfolio. Or after reading this (https://www.bogleheads.org/wiki/I_Bonds_vs_TIPS) maybe TIPS instead so I could buy it all at once.
TIPS are, on historic evidence, actually more volatile than straight bonds. BUT if inflation ever picks up, then TIPS offer better protection. A Short Term TIPS fund will be less volatile than the full TIPS fund, but in terms of expected after inflation returns (real yields) the full TIPS fund is going to give you better long run returns, most likely.

If inflation is below expectations, straight (nominal) Treasury bonds will outperform TIPS. If the other way, TIPS will outperform.

Make sure you understand how taxes work with TIPS bonds - inflation can cause you more tax as I understand it.

There is an thread now about an absolutely excellent presentation on TIPS, made by a Boglehead (the slides are online).

noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Wed Apr 11, 2018 12:30 pm

Thanks for the response ofckrupke. Sorry it's taken a while but work got in the way.
ofckrupke wrote:
Sun Apr 08, 2018 5:58 pm
Two small points:

If one is splitting CA and national muni funds to reduce risk and targeting an overall intermediate duration, it's more tax efficient to split as short-term national plus long-term CA. (I get the impression the OP's holdings might have hewn closer to this approach prior to recent TLH.)
I had thought short/limited term national (VMLUX, low returns) and long term CA (VCLAX, too much interest rate risk) weren't favored. I use them for my TLH pairings but didn't plan to keep them longer term.
ofckrupke wrote:
Sun Apr 08, 2018 5:58 pm
In the OP's tax brackets, as long as TISM is distributing ~1% more dividends annually than TSM (and almost all of that difference in non-qualified form!), lower tax drag is achieved by holding the TISM in tax-advantaged accounts. About 0.48% (0.44% +0.038 for NIIT) for the difference in dividend vs. ~0.20% FTC (7% x ~2.9%), so a bit more than a quarter percent per year, neglecting effects due to disparities in fund costs across the various accounts. Of course, the tax cost for the OP to shuffle existing holdings might be far greater, but something to think about for new money...
This one I'll have to consider for future and compare the dividends. Following BH's tax efficient placement, my TISM in taxable because of the foreign tax credit. You're right that I have TISM LTCG that I'd rather not pay taxes on yet. I also don't have much tax-advantaged space to play with. All traditional 401k is in bonds now but do you mean shifting Roth from TSM to TISM when rebalancing or adding new funds?

noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Wed Apr 11, 2018 12:44 pm

Valuethinker wrote:
Mon Apr 09, 2018 11:30 am

1. less risk. They are assumed to be of no credit risk. If a default resulted for political reasons, unless it was swiftly reversed, then all heck would break loose in world financial markets. I normally revel in gloom-and-doom scenarios but that one tests even me... I assume good sense on the part of US politicians (I know, I know, but this is trillions of dollars of securities and core to financial markets that we are talking about ...)

2. in the case of deflation & lower future interest rates, they are the best protection. David Swensen spends a lot of time on this but, basically:

- US mortgage backed securities (Agency issued) are credit risk free but have extension/ prepayment risk-- basically duration (interest rate sensitivity) goes against you (changes)

- corporate bonds are often callable (and have credit risk, which is bad) - so if interest rates drop, the issuer will simply call the bonds and you lose the lock in of a higher yield that was available when you bought

- US Treasury bonds will simply hold to maturity, so your coupon and redemption are worth more. For a fund, the price/ NAV will probably go up

- I am not US based, but as I understand it, you don't pay state tax on the interest on US Treasury Bonds? (don't take my word for it)

Thus US Treasury bonds are the ultimate "plain vanilla" form of bond investing. This, I think, is why Larry Swedroe and David Swensen recommend them. UST bond funds behave in the same ways, except the duration is more or less constant-- whereas with individual bonds, the duration drops as the bonds move closer to maturity.

Municipal bonds may be preferred if they give you a higher after tax return. In the case of CA, my understanding is the fiscal position is quite strong, at least until the next recession/ tech crash. If we were talking about Illinois, I would urge real caution.

Note to be clear, one should not own individual municipal bonds. That only works if you have experience as a credit analyst-- and even they get it wrong. Different bonds, even issued by the same entity, have different rights as to security & repayment. For example project-related bonds generally (as I understand it) have higher default rates if they are only going to be repaid by the cash flows of the project, not by General Obligation on the taxpayer.

TIPS are, on historic evidence, actually more volatile than straight bonds. BUT if inflation ever picks up, then TIPS offer better protection. A Short Term TIPS fund will be less volatile than the full TIPS fund, but in terms of expected after inflation returns (real yields) the full TIPS fund is going to give you better long run returns, most likely.

If inflation is below expectations, straight (nominal) Treasury bonds will outperform TIPS. If the other way, TIPS will outperform.

Make sure you understand how taxes work with TIPS bonds - inflation can cause you more tax as I understand it.

There is an thread now about an absolutely excellent presentation on TIPS, made by a Boglehead (the slides are online).
Thanks Valuethinker. You've provided quite a bit for me to think about. Yes I would definitely stick with muni bond funds vs. individual. And I've taken a while to arrive at my current portfolio which I'm trying to keep as simple as I can (the concept of a "lazy portfolio" was a draw for me) so these might wait until I have more time to research/calculate sometime in the future.

ofckrupke
Posts: 461
Joined: Mon Jan 10, 2011 2:26 pm

Re: Alternatives to muni bonds? (and portfolio update)

Post by ofckrupke » Wed Apr 11, 2018 1:06 pm

noobogle wrote:
Wed Apr 11, 2018 12:30 pm
Thanks for the response ofckrupke. Sorry it's taken a while but work got in the way.
ofckrupke wrote:
Sun Apr 08, 2018 5:58 pm
Two small points:

If one is splitting CA and national muni funds to reduce risk and targeting an overall intermediate duration, it's more tax efficient to split as short-term national plus long-term CA. (I get the impression the OP's holdings might have hewn closer to this approach prior to recent TLH.)
I had thought short/limited term national (VMLUX, low returns) and long term CA (VCLAX, too much interest rate risk) weren't favored. I use them for my TLH pairings but didn't plan to keep them longer term.
The idea I was getting at was to combine two or more flavors of muni funds so as to
1) limit the interest rate risk of the composite to that of an intermediate term fund, AND
2) limit the bonds from (one's own high-taxing) single state to something like half the composite, AND
3) still get the fed and state tax exemptions on much more than half of the interest/dividend income.
noobogle wrote:
Wed Apr 11, 2018 12:30 pm
ofckrupke wrote:
Sun Apr 08, 2018 5:58 pm
In the OP's tax brackets, as long as TISM is distributing ~1% more dividends annually than TSM (and almost all of that difference in non-qualified form!), lower tax drag is achieved by holding the TISM in tax-advantaged accounts. About 0.48% (0.44% +0.038 for NIIT) for the difference in dividend vs. ~0.20% FTC (7% x ~2.9%), so a bit more than a quarter percent per year, neglecting effects due to disparities in fund costs across the various accounts. Of course, the tax cost for the OP to shuffle existing holdings might be far greater, but something to think about for new money...
This one I'll have to consider for future and compare the dividends. Following BH's tax efficient placement, my TISM in taxable because of the foreign tax credit. You're right that I have TISM LTCG that I'd rather not pay taxes on yet. I also don't have much tax-advantaged space to play with. All traditional 401k is in bonds now but do you mean shifting Roth from TSM to TISM when rebalancing or adding new funds?
By tax advantaged I generally mean the union of tax-deferred and tax-exempt. But in your case I meant the Roths that hold something like 8% of your portfolio because it was easy to imagine a simple tit for tat switch (in the absence of CG tax cost in the taxable account anyway),at least for half of your TISM.
But apart from the Roths only offering half the necessary capacity: if something like 10% of the TISM in taxable is LTCG, more or less evenly distributed across the tax lots, then your tax cost would be around 2.8% to switch any particular lot, and that's over ten years' worth of the sort of unit tax saving I suggest might result from holding TISM in tax advantaged and TSM in taxable (in your current brackets, and with the current/recent-past dividend yields of TISM and TSM). I typically would not make such a move now, since the probability of being able to do it at some point in the next few years for zero tax cost after a market downturn is high.

As prefaced, this is small ball. And as others have noted, your allocation and locations are already clean and sensible.

jpsc
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Joined: Sat Feb 10, 2018 11:05 pm

Re: Alternatives to muni bonds? (and portfolio update)

Post by jpsc » Wed Apr 11, 2018 5:52 pm

You could buy that Vanguard Target Retirement Income Trust .

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dratkinson
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Location: Centennial CO

Re: Alternatives to muni bonds? (and portfolio update)

Post by dratkinson » Thu Apr 12, 2018 11:56 am

noobogle wrote:
Sat Apr 07, 2018 11:30 am
...
2. Anything I should change/consider with my investments now or in preparation for retirement? Perhaps move more to CDs.
See current topic 'The "mechanics" of retiring': viewtopic.php?f=2&t=246834

In it follow link to Peter Foley's topic on what to do during the retirement "Red Zone"---the 5 years before and after retirement.



Suggested books.
"The Boglehead's Guide to Retirement Planning".
Quinn's "How to Make Your Money Last".
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

noobogle
Posts: 16
Joined: Sun Jan 22, 2017 3:14 am

Re: Alternatives to muni bonds? (and portfolio update)

Post by noobogle » Wed May 16, 2018 12:01 pm

Sorry for the belated response but it's been crazy at work lately as I'm stepping out of the rat race in a few weeks.

Thanks to dratkinson, jpsc and ofckrupke for the additional inputs. I'll definitely have to read up on those resources with my newfound free time. But I think I'm going to have to remind myself that I don't spending too much time trying to optimize our plan with a million tweaks when it's probably already good enough for the long haul.

Valuethinker, I thought of your advice last week when the Fidelity rep was trying to convince me that bond index funds were a bad idea and individual bonds were the only way to go in our rising interest rate environment (but only if I work with one of their bond advisors to get it right).

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