US Treasuries vs Munis in taxable

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Jefferson
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Joined: Wed Feb 21, 2018 1:37 pm

US Treasuries vs Munis in taxable

Post by Jefferson » Tue Jul 10, 2018 10:04 pm

I'm asking solely about US bond funds in a taxable account. I am in the highest federal tax bracket, with a 6% state tax rate.

Short version - Why not VGIT over VTEB in taxable? (Intermediate US Treasuries vs Intermediate Tax Exempt)

Long version - I've seen many threads that suggest an Intermediate Term Tax-Exempt bond fund in taxable accounts. For a Vanguard ETF, I believe this would be VTEB (please correct me if I am wrong). As I understand it, the goal there is to reduce taxes, which is surely a good thing. But should taxes be the only consideration here? What about the added risk (however slight) of municipal bonds vs US Treasuries? I would think that, between the two, munis carry a higher risk of default than US Treasuries. My question is whether that difference in risk is enough to outweigh the tax advantage.

Bonus question - Why not BND in taxable? How does the return of Total Bond Market weigh against the lower taxes of VTEB or VGIT?

radiowave
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Joined: Thu Apr 30, 2015 5:01 pm

Re: US Treasuries vs Munis in taxable

Post by radiowave » Tue Jul 10, 2018 10:18 pm

Jefferson, welcome to the forum. Here's a link to the Bogleheads Wiki that discusses tax efficient placement: https://www.bogleheads.org/wiki/Tax-ef ... placement . This would be the best place to start and if you have additional questions, please feel free to ask.
Bogleheads Wiki: https://www.bogleheads.org/wiki/Main_Page

mcraepat9
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Joined: Thu Jul 16, 2015 11:46 am

Re: US Treasuries vs Munis in taxable

Post by mcraepat9 » Tue Jul 10, 2018 10:27 pm

Jefferson wrote:
Tue Jul 10, 2018 10:04 pm
I'm asking solely about US bond funds in a taxable account. I am in the highest federal tax bracket, with a 6% state tax rate.

Short version - Why not VGIT over VTEB in taxable? (Intermediate US Treasuries vs Intermediate Tax Exempt)

Long version - I've seen many threads that suggest an Intermediate Term Tax-Exempt bond fund in taxable accounts. For a Vanguard ETF, I believe this would be VTEB (please correct me if I am wrong) If you are only using Vanguard ETFs, then yes. There are other muni options at Vanguard (VWIUX) and outside (MUB, BMBIX). As I understand it, the goal there is to reduce taxes, which is surely a good thing. But should taxes be the only consideration here? What about the added risk (however slight) of municipal bonds vs US Treasuries? I would think that, between the two, munis carry a higher risk of default than US Treasuries. My question is whether that difference in risk is enough to outweigh the tax advantage. I agree with you 100% - Treasuries are riskless, munis are not. That's why I use the Baird muni fund (BMBIX) as opposed to the other muni options at Vanguard - I found it to be the muni fund that has the safest, highest rated muni bonds - safer than Vanguard and MUB. I do think, however, that saving 30% taxes on bond interest is worthwhile. I think that if you stick with the safest munis you can find, and not try to reach for yield (i.e. introduce risk into your "safe" assets), i think munis can be make sense. I would note that, for the most part, people are not comparing munis vs. Treasuries in taxable. They are comparing munis in taxable accounts vs. Treasuries in tax-advantaged accounts due to the tax treatment of Treasuries. Avoiding state income tax alone usually isn't enough of a sweetener.

Bonus question - Why not BND in taxable? I would not hold BND anywhere - I hold only Treasuries/savings bonds and muni bonds. But assuming you determined that you wanted to hold BND, it of course should not be held in taxable - you are paying full freight on taxes on BND's interest payments (your highest marginal state and local tax rate). Hard to imagine that making sense.How does the return of Total Bond Market weigh against the lower taxes of VTEB or VGIT? Have not compared (and won't compare). Corporate bonds do not make any sense to me (see http://www.etf.com/sections/index-inves ... nopaging=1). I think if you are holding fixed income in taxable accounts, it is likely that munis make the most sense if you're in the top tax bracket. Like you, I agree there is added risk in munis vs. Treasuries. Thus, I am laser focused on making sure I have the safest munis I can find - hence my use of BMBIX.
Amateur investors are not cool-headed logicians.

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patrick013
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Re: US Treasuries vs Munis in taxable

Post by patrick013 » Tue Jul 10, 2018 10:36 pm

Jefferson wrote:
Tue Jul 10, 2018 10:04 pm
My question is whether that difference in risk is enough to outweigh the tax advantage.
If there is a return advantage after tax the added risk is mitigated
by broad diversification. Most of those muni funds own thousands
and thousands of bonds. So being investment grade the risk of
default there is smallish also but not nonexistent. Some AA for
muni's would lessen taxes I think. The VG muni money market fund
is very safe. All mig-1 investments. That would diversify into muni's
at the highest short term rating.
age in bonds, buy-and-hold, 10 year business cycle

printer
Posts: 124
Joined: Mon Dec 15, 2014 12:37 am

Re: US Treasuries vs Munis in taxable

Post by printer » Wed Jul 11, 2018 12:36 pm

You could ask a different question: why not both in taxable?

Jefferson
Posts: 5
Joined: Wed Feb 21, 2018 1:37 pm

Re: US Treasuries vs Munis in taxable

Post by Jefferson » Wed Jul 11, 2018 10:25 pm

printer wrote:
Wed Jul 11, 2018 12:36 pm
You could ask a different question: why not both in taxable?
That's actually what I was thinking. How would this look for my bond allocation in taxable?

50% - VGIT
50% - VTEB

afan
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Joined: Sun Jul 25, 2010 4:01 pm

Re: US Treasuries vs Munis in taxable

Post by afan » Thu Jul 12, 2018 7:14 am

According to Portfolio Visualizer
April 2001-present
VWIUX had higher return and higher Sharpe ratio than BMBIX.
VWIUX had a very slightly higher standard deviation, by 0.07%. Negligible.

BMBIX had a worst year drawdown of -1.19%, slightly better than VWIUX worst year of -1.48%.

This period included the great recession.
To whatever extent the difference in average credit rating between the two funds reflects an actual difference in credit quality, it does not seem to have mattered. There has long been a practice of using stricter criteria for rating Muni than corporate debt. For bonds with the same rating corporates have higher default rates than munis. In other words, many munis that have less than AAA ratigns would be AAA based on default risk if they were corporate. So the difference between a Muni fund with an average rating of AA and one that is AAA may not reveal any difference in risk.

Over these turbulent times the Baird fund has not shown itself to be safer than VWIUX, so I don't consider it worth paying any extra for it.

The credit risk of a high quality Muni fund is way too small to worry about. Before I get down to caring about this level of difference, if any differential risk exists, then I should be zero percent in stocks, which dwarf munis in risk.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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