2-year AA Munis at Vanguard and Fidelity Today

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gmaynardkrebs
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Tue Apr 24, 2018 6:54 am

Does the EMH not apply to munis? Swedroe's book quote, above, only implies saving the costs of a bond fund by going DIY. Kevin and others seem to feel they are exploiting arbitrage opportunities, or liquidity premia perhaps, and I must say it looks that way to me. But, a reality test suggests this is unlikely, or that the gain from all this effort would be trivial, especially for a small investor, Thoughts?

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mehitabel » Tue Apr 24, 2018 8:17 am

stlutz wrote:
Mon Apr 23, 2018 11:47 pm
But my understanding is that individual bonds, (Including perhaps in a rolling ladder) are safer than funds because if you hold the individual bonds til maturity, you will not have a loss on the principal -- with bond funds, you don't have that control.
Muni bonds are rarely issued or trade at par. Suppose someone buys a bond for $110 and it pays $5 in interest per year. At maturity, they get $100 back.

Did this person get their money back at maturity? If not, what would they need to do to make sure they did?
My understanding (and I'm new at this!) is that par is what you get back at maturity. You'd get back $100. Also, you have to pay attention to the true yield. In this case, let's say, the initial offer was for a $100 bond with a 5% yield. If you then buy that bond for $110 dollars, then (according to my math) the actual yield will be only 4.5%

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by misterno » Tue Apr 24, 2018 10:09 am

Kevin M wrote:
Sat Apr 14, 2018 12:22 pm
Mydanyale wrote:
Fri Apr 13, 2018 5:11 pm
@Kevin

Re: Kaiser bonds
I hope you do realize that you bought the bonds above par, and upon maturity in a year, in total return, you will be losing money.
The yield to maturity calculation factors in both the change in value of the bond from time of purchase to maturity (capital return) and the coupon payments (income return). The magnitude of the positive income return will be larger than that of the negative capital return, so the yield is positive.

Here's a simplified way of looking at it that ignores the time value of money, the small amount of accrued interest (that the seller of the bond got), and the fact that maturity is slightly less than one year.

The coupon rate of the bond is 5%, so for the $10,000 of face value I bought,I will receive $500 in coupon payments in the approximately one year to maturity. Since I paid 103.14 (including commission), the initial value is $10,314, and since the bond matures at 100 ($10,000), the capital return component is -$314. So the net dollar return is 500 - 314 = 186. Using this simplified model, the return is 186 / 10,314 = 1.80%.

Here's a more accurate calculation. The accrued interest (paid to seller) was $22.22, so subtracting this from the $500 in coupon payments leaves 477.78 as the actual income component, and net dollar return is 477.78 - 314 = 163.78. This gives me a net return of 1.59%. The actual maturity of the bond is about 11.5 months, so annualized return is increased to 1.59% / 11.5 * 12 = 1.66%.

The yield calculated with the spreadsheet YIELD function is 1.673%, which is a smidge higher than the simplified calculation, since the discounted value of the first coupon payment is higher than if it were received at the end of the term. This can be verified by changing the frequency parameter (coupon payments per year) in the YIELD function from 2 to 1, which then gives a yield of 1.66%.

Kevin
Kevin

Correct me if I am wrong but the YIELD function in excel only works properly if you invest the money the same day of the coupon payment

but if you invest in between coupon payments you need to use XIRR function like the one below.

In my experience YIELD function does not give you annual return XIRR does

Image

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Tue Apr 24, 2018 3:33 pm

ofckrupke wrote:
Mon Apr 23, 2018 11:24 am
Kevin M wrote:
Mon Apr 23, 2018 10:59 am
Today I bought an AA+ CA muni at 1.602% net maturing 10/1/2018, so 0.44 year maturity, and I get the state tax exemption which I wouldn't get with the fund. For me this is TEY of 2.465%, so 57 bps/year relative to 0-year CA muni MM at 2.20% TEY.
[...]
Of course buying individual munis is much more complicated and time consuming.
Folks playing at home might like to know that based on a 10k investment the difference in return over the 0.44y between these two - expected, of course, because who knows what the muni MMF will actually earn between now and 10/1/2018, or whether Kevin will flip the bond before it matures - is about $7.33 (tax-free, of course).
Sure, if you just take this one bond and think only in dollar terms, you could make the same argument for extending maturity at all for each rung of a bond ladder, and you might as well just stick with a money market fund. Same is true for the individual bonds in a short-term muni bond fund. But in the overall ladder it all adds up, just like it does in a short-term muni bond fund.

You could also make a similar argument for paying a lower expense ratio for a bond fund, yet that seems to be something important to most people.

Just as with expense ratios, I decent yield premium here and there compounds over the years and adds up to real money, especially with a larger portfolio and very high fixed-income allocation.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Tue Apr 24, 2018 3:51 pm

happenstance wrote:
Mon Apr 23, 2018 10:51 pm
Another great fixed-income thread from Kevin. A couple of comments/questions:

Are you screening out callable bonds in your search? Call options seem like they would create a hassle when managing an individual bond portfolio, especially at the maturities you purchase.
Yes. Calls give an asymmetric advantage to the issuer, and screening them out also seems to screen out extraordinary redemptions, which I definitely don't want to mess with.
Have you only looked on the secondary market, or do you also consider new issues?
So far just secondary market.
I ask because in The Only Guide to a Winning Bond Strategy You'll Ever Need <snip>
Larry has also pointed out that the best deals often are for small lots, and that's exactly what I've found, both with munis and secondary CDs. I don't know how institutional traders trade, but perhaps they're getting more like dealer pricing (I sometimes see trades where there is no markup or commission from the dealer pricing).
But it does appear possible to exercise control over the markup on the secondary market. The impact of the commission is calculable, so it the main concern is the spread. This thread shows there are some good deals out there—even at smaller lot sizes—and you can figure the exact yield you get at time of purchase.
Yes, and even the bid/ask spread is not a concern to me if I'm only buying and holding to maturity, which is my intention. What matters most is that I'm getting a risk-adjusted yield that beats anything else I can get at that maturity on a taxable-equivalent basis in the account type of interest, which for munis is taxable, and that the yield premium for extending maturity is acceptable to me.

Still, I sometimes view recent trades, and if I see a very recent non-dealer buy price that's much lower than the current ask + commission, I might give it a pass.
I've been poking around on Schwab's fixed income site, and I notice that new issue munis come in two offering styles: negotiated and competitive. At Schwab, you can only place online orders for negotiated new issues, while competitive ones require calling a Fixed Income Specialist. And unlike on the secondary market, it seems you don't know the exact allocation and pricing you get until after the order settles. So to my (admittedly untrained) eyes, the secondary market is in some ways preferable to the primary market.
Yes, not knowing the yield I'll get makes me a little uncomfortable.
As I'm currently in the accumulation stage, I do not need the complexity of an individual muni bond portfolio right now (iShares New York Muni Bond ETF/NYF meets my needs well). But later on I could see adopting an individual bond portfolio, and I may purchase a muni bond or two in the interim just to get a sense of the mechanics.
Makes sense.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Tue Apr 24, 2018 4:07 pm

... I may purchase a muni bond or two in the interim just to get a sense of the mechanics.
Just be a little careful on this re the tax reporting for discount bonds re yearly accrual. My understanding is that making an election regarding even one bond can impact how you must report on all discount bonds purchased that year, which is not always advantageous. I don't understand much beyond that, unfortunately, except that it gave me pause.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Tue Apr 24, 2018 4:15 pm

gmaynardkrebs wrote:
Tue Apr 24, 2018 6:54 am
Does the EMH not apply to munis?
There are what you might call anomalies. Perhaps it's easier to understand with CDs, since there is essentially no credit risk. Even though a new issue 2-year CD might selling for 2.75%, you might get 2.80% or even 2.85% for same maturity on secondary market--maybe even for the exact same CD (though not earlier today when I did my CD screen). Or you might get a 1.8-year CD at 2.75% net yield in a few days. Same kind of thing occurs in muni market.
Swedroe's book quote, above, only implies saving the costs of a bond fund by going DIY.

That book doesn't really seem to capture all of Larry's thoughts about building a ladder of individual munis. Did you see his reply to my OP (it was the first reply in the thread)? Fun to see Larry posting a reply to my OP, since we haven't seen him posting here lately.
Kevin and others seem to feel they are exploiting arbitrage opportunities, or liquidity premia perhaps, and I must say it looks that way to me. But, a reality test suggests this is unlikely, or that the gain from all this effort would be trivial, especially for a small investor, Thoughts?
I've laid out my reasoning earlier in the thread. There are a number of advantages to me in using individual munis for this particular sub-portfolio, but I don't want to repeat it all again--you can read my earlier replies in the thread if you're actually interested.

I expect that the vast majority of Bogleheads will stick only with bond funds, but I think it's useful for some and certainly interesting to me to share what I'm doing and to hear inputs from others who also are involved with it or interested in it.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Tue Apr 24, 2018 4:27 pm

misterno wrote:
Tue Apr 24, 2018 10:09 am
Kevin

Correct me if I am wrong but the YIELD function in excel only works properly if you invest the money the same day of the coupon payment

but if you invest in between coupon payments you need to use XIRR function like the one below.

In my experience YIELD function does not give you annual return XIRR does

Image
I think the YIELD function is specifically designed to work correctly regardless of when you buy the bond. If I have time, I'll play around with XIRR and see if I can show this. There may be some small differences to the different daycount conventions used for bonds--you get a different yield depending on which daycount convention you use, and XIRR does not have this functionality built in--I assume it's basically actual/actual, which often is used for CDs (and actual/365 if not), but munis mostly if not always use 30/360.

Perhaps you're ignoring the accrued interest in your XIRR calculations? Your initial cash outflow will be larger than your net price times quantity because you also pay the accrued interest.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Tue Apr 24, 2018 4:37 pm

Kevin M wrote:
Tue Apr 24, 2018 4:15 pm
gmaynardkrebs wrote:
Tue Apr 24, 2018 6:54 am
Does the EMH not apply to munis?
There are what you might call anomalies. Perhaps it's easier to understand with CDs, since there is essentially no credit risk. Even though a new issue 2-year CD might selling for 2.75%, you might get 2.80% or even 2.85% for same maturity on secondary market--maybe even for the exact same CD (though not earlier today when I did my CD screen). Or you might get a 1.8-year CD at 2.75% net yield in a few days. Same kind of thing occurs in muni market.
Swedroe's book quote, above, only implies saving the costs of a bond fund by going DIY.

That book doesn't really seem to capture all of Larry's thoughts about building a ladder of individual munis. Did you see his reply to my OP (it was the first reply in the thread)? Fun to see Larry posting a reply to my OP, since we haven't seen him posting here lately.
Kevin and others seem to feel they are exploiting arbitrage opportunities, or liquidity premia perhaps, and I must say it looks that way to me. But, a reality test suggests this is unlikely, or that the gain from all this effort would be trivial, especially for a small investor, Thoughts?
I've laid out my reasoning earlier in the thread. There are a number of advantages to me in using individual munis for this particular sub-portfolio, but I don't want to repeat it all again--you can read my earlier replies in the thread if you're actually interested.

I expect that the vast majority of Bogleheads will stick only with bond funds, but I think it's useful for some and certainly interesting to me to share what I'm doing and to hear inputs from others who also are involved with it or interested in it.

Kevin
Thanks Kevin, I've really enjoyed your insights. I'm envious of your knowledge and quite tempted to stick my toe in myself, but I fear I've lost too many little grey cells over the years to trod your path successfully.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mrmetalpole » Wed May 16, 2018 1:40 pm

Unsure if this has been covered previously, so apologies if it has.....beyond index funds, striving to structure that generates a safe passive income stream, would a muni-bond ladder be worth considering? Had conversation with Fidelity's fixed income specialist recently and waiting on proposal for consideration. Asked about fees and will continue further w/questions. It seems that it would be more tax-advantaged (generally speaking) to use a muni-bond ladder for an expected safe rate of return (4-5% for bonds marked 2/3A), as opposed to CDs. In a rising rate environment, would this approach be sensible to consider? Appreciate feedback. As background, high tax bracket, live in a high tax state - Thanks

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Wed May 16, 2018 4:41 pm

Mrmetalpole wrote:
Wed May 16, 2018 1:40 pm
Unsure if this has been covered previously, so apologies if it has.....beyond index funds, striving to structure that generates a safe passive income stream, would a muni-bond ladder be worth considering? Had conversation with Fidelity's fixed income specialist recently and waiting on proposal for consideration. Asked about fees and will continue further w/questions. It seems that it would be more tax-advantaged (generally speaking) to use a muni-bond ladder for an expected safe rate of return (4-5% for bonds marked 2/3A), as opposed to CDs. In a rising rate environment, would this approach be sensible to consider? Appreciate feedback. As background, high tax bracket, live in a high tax state - Thanks
A few comments.

First, I obviously think it's worth considering, because I've been building such a ladder. However, due to yield curve, have been keeping maturities to less than three years. I would also consider including Treasuries in this ladder--for me Treasuries now have about same taxable yield as AA/AA2 (i.e, above AA-/AA3) munis, except for some outliers, and there's often a reason they are outliers. This is at 27% fed marginal and 8% state marginal. If your fed marginal rate is higher, munis could be relatively more attractive, but if your state rate is higher, this will also increase taxable-equivalent yields (TEYs) for Treasuries.

You almost certainly will come out better with either munis or Treasuries than CDs at high tax rates in the current environment.

Regarding safety, AA munis have a 0.00% cumulative 4-year default rate, and a 0.01% 5-10 year cumulative default rate for the period 1970-2011, so if you go by history, they are very safe. However, good to keep in mind that just because something hasn't happened before doesn't mean it won't happen, so I would still be careful, and look closely at each muni, and this is a lot of work. For example, I own a muni that S&P rates AA but Moody's rates A1--who do we trust more? So unless you're getting a nice TEY yield premium over a Treasury of same maturity, might want to just stick with the Treasury.

The only fee Fidelity charges is $1/bond, so 0.1%. Unless you are paying them for some additional service, this is what you will pay. I calculate the net TEY after commission in evaluating munis. Fidelity displays the net yield (not TEY though) in the purchase preview screen.

We have been in a rising rate environment, but we don't know how long it will continue, or how much yields will increase. If this is your concern, then the best bet is to stick with maturities of no longer than three years, as the yield curves flatten out quite a bit after that. Steeper yield curve provides more buffer against rising yields, and shorter maturities allow you to roll more quickly to higher yields if yields do indeed continue rising.

Of course shorter-term yields could increase while intermediate-term yields don't, so staying short-term is no guarantee that you'll do better, but I think the risk/return balance is best at maturities of less than three years.

Finally, you're not going to earn 4-5% for AA munis.I think you are looking at coupon rate, but your return is based on yield to maturity, which is much lower. On a 2-year AA muni that I would consider buying, the coupon rate is 5%, but the yield is about 2.19%, and the net (after commission) yield is about 2.14%, which for me is net TEY of 3.02%. The yield curve for munis I'd consider buying is pretty flat from 2-year to 3-year maturity, so you won't do much better with a 3-year AA muni.

For comparison, TEY of 2-year Treasury for me is about 2.9%, so about 12 basis points less than the muni, and 3-year Treasury TEY is about 3.1%, so about 10 bps more than a 3-year muni I'd consider buying.

An example of an outlier is a 2.63-year muni (also with 5% coupon), yield of 2.38%, net yield of 2.34%, and net TEY for me of 3.32%. This is a CT bond that S&P rates AA but Moody's only rates A1. This probably is OK, given that the 3-year default rate of A-rated bonds is 0.01%, but there's probably a reason this yield is so much higher than the competition. This is where you need to decide if the extra yield is worth the probably small but not zero risk of default.

You will tend to find the outliers in the same states: NJ, CT and IL, especially IL. I now exclude IL from my searches, as I already have as much in IL as I want, so the examples here exclude IL.

Bottom line is that I was buying mainly munis from late last year until about a month ago, when I had invested what I wanted to at the time, but now I am looking more closely at Treasuries, as the only munis with sufficient yield premiums typically have an explanation for the higher yield. However, now and then one pops up that seems just like an anomaly, and those could be worth buying. I saw one like this yesterday, but by the time I decided I might buy it, someone else had picked it up.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Wed May 16, 2018 5:03 pm

Kevin, which Treasuries are you looking at. Can one realistically expect inefficient pricing opportunities in the treasury market? Wouldn’t it have to be more of an intermediation type of situation?

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What about the Lazy Way?

Post by hudson » Wed May 16, 2018 5:04 pm

Kevin,

I'm sure you've answered this before in many places.
How bad would it be to just go with Vanguard Intermediate Muni Admiral VWIUX...or iShares National Muni Bond ETF...MUB?
or Baird's (Conservative) Intermediate Muni BMBIX?

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mrmetalpole » Wed May 16, 2018 7:01 pm

Kevin M wrote:
Wed May 16, 2018 4:41 pm
Mrmetalpole wrote:
Wed May 16, 2018 1:40 pm
Unsure if this has been covered previously, so apologies if it has.....beyond index funds, striving to structure that generates a safe passive income stream, would a muni-bond ladder be worth considering? Had conversation with Fidelity's fixed income specialist recently and waiting on proposal for consideration. Asked about fees and will continue further w/questions. It seems that it would be more tax-advantaged (generally speaking) to use a muni-bond ladder for an expected safe rate of return (4-5% for bonds marked 2/3A), as opposed to CDs. In a rising rate environment, would this approach be sensible to consider? Appreciate feedback. As background, high tax bracket, live in a high tax state - Thanks
A few comments.

First, I obviously think it's worth considering, because I've been building such a ladder. However, due to yield curve, have been keeping maturities to less than three years. I would also consider including Treasuries in this ladder--for me Treasuries now have about same taxable yield as AA/AA2 (i.e, above AA-/AA3) munis, except for some outliers, and there's often a reason they are outliers. This is at 27% fed marginal and 8% state marginal. If your fed marginal rate is higher, munis could be relatively more attractive, but if your state rate is higher, this will also increase taxable-equivalent yields (TEYs) for Treasuries.

You almost certainly will come out better with either munis or Treasuries than CDs at high tax rates in the current environment.

Regarding safety, AA munis have a 0.00% cumulative 4-year default rate, and a 0.01% 5-10 year cumulative default rate for the period 1970-2011, so if you go by history, they are very safe. However, good to keep in mind that just because something hasn't happened before doesn't mean it won't happen, so I would still be careful, and look closely at each muni, and this is a lot of work. For example, I own a muni that S&P rates AA but Moody's rates A1--who do we trust more? So unless you're getting a nice TEY yield premium over a Treasury of same maturity, might want to just stick with the Treasury.

The only fee Fidelity charges is $1/bond, so 0.1%. Unless you are paying them for some additional service, this is what you will pay. I calculate the net TEY after commission in evaluating munis. Fidelity displays the net yield (not TEY though) in the purchase preview screen.

We have been in a rising rate environment, but we don't know how long it will continue, or how much yields will increase. If this is your concern, then the best bet is to stick with maturities of no longer than three years, as the yield curves flatten out quite a bit after that. Steeper yield curve provides more buffer against rising yields, and shorter maturities allow you to roll more quickly to higher yields if yields do indeed continue rising.

Of course shorter-term yields could increase while intermediate-term yields don't, so staying short-term is no guarantee that you'll do better, but I think the risk/return balance is best at maturities of less than three years.

Finally, you're not going to earn 4-5% for AA munis.I think you are looking at coupon rate, but your return is based on yield to maturity, which is much lower. On a 2-year AA muni that I would consider buying, the coupon rate is 5%, but the yield is about 2.19%, and the net (after commission) yield is about 2.14%, which for me is net TEY of 3.02%. The yield curve for munis I'd consider buying is pretty flat from 2-year to 3-year maturity, so you won't do much better with a 3-year AA muni.

For comparison, TEY of 2-year Treasury for me is about 2.9%, so about 12 basis points less than the muni, and 3-year Treasury TEY is about 3.1%, so about 10 bps more than a 3-year muni I'd consider buying.

An example of an outlier is a 2.63-year muni (also with 5% coupon), yield of 2.38%, net yield of 2.34%, and net TEY for me of 3.32%. This is a CT bond that S&P rates AA but Moody's only rates A1. This probably is OK, given that the 3-year default rate of A-rated bonds is 0.01%, but there's probably a reason this yield is so much higher than the competition. This is where you need to decide if the extra yield is worth the probably small but not zero risk of default.

You will tend to find the outliers in the same states: NJ, CT and IL, especially IL. I now exclude IL from my searches, as I already have as much in IL as I want, so the examples here exclude IL.

Bottom line is that I was buying mainly munis from late last year until about a month ago, when I had invested what I wanted to at the time, but now I am looking more closely at Treasuries, as the only munis with sufficient yield premiums typically have an explanation for the higher yield. However, now and then one pops up that seems just like an anomaly, and those could be worth buying. I saw one like this yesterday, but by the time I decided I might buy it, someone else had picked it up.

Kevin
Thank you very much for the feedback. Perhaps I’ll share the proposed ideas that Fidelity fixed income claims would safely yield 4-5% via munis if they follow-up as stated. Thanks again,

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Wed May 16, 2018 7:51 pm

gmaynardkrebs wrote:
Wed May 16, 2018 5:03 pm
Kevin, which Treasuries are you looking at. Can one realistically expect inefficient pricing opportunities in the treasury market? Wouldn’t it have to be more of an intermediation type of situation?
Sorry, I don't understand the question. I don't expect inefficient pricing opportunities in the Treasury market. What did I say that led you to that conclusion?

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Re: What about the Lazy Way?

Post by Kevin M » Wed May 16, 2018 8:00 pm

hudson wrote:
Wed May 16, 2018 5:04 pm
Kevin,

I'm sure you've answered this before in many places.
How bad would it be to just go with Vanguard Intermediate Muni Admiral VWIUX...or iShares National Muni Bond ETF...MUB?
or Baird's (Conservative) Intermediate Muni BMBIX?
It may not be bad for you, but based on my situation, I don't want to add money to intermediate-term muni bond funds. I do continue to hold my positions in the Vanguard int-term and-long term CA muni funds, but I'm not adding to them. I did reopen a position in limited-term tax exempt a few months ago, but even that is pushing the boundaries of what I consider to be optimal risk/return balance for me.

I think I've already explained my reasoning at length in this thread and in the thread I have going on yield curves, so I would just be repeating myself to explain it again. As I said in an earlier reply today, I'm now leaning toward Treasuries in preference to munis, but will keep my eye open for apparently anomalous muni deals that offer sufficient yield premiums over Treasuries but without any downsides that I can determine.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Wed May 16, 2018 8:17 pm

Mrmetalpole wrote:
Wed May 16, 2018 7:01 pm
Thank you very much for the feedback. Perhaps I’ll share the proposed ideas that Fidelity fixed income claims would safely yield 4-5% via munis if they follow-up as stated. Thanks again,
That would be great.

I can tell you for sure that they are talking either in terms of taxable-equivalent yield or current yield, and even if TEY, you would need to extend maturity to 10 years to get into the 5% ballpark. Current yield is not a good measure of return, so don't get fooled by it. You want to look at yield to maturity, as that incorporates price change from now until maturity as well as interest payments.

If you tell me your marginal federal and state income tax rates, I can show you some yield curves based on those tax rates. At my tax rates, Fidelity summary page shows a 10-year AA muni with TEY of 4.84% (yield of 3.42%), but I doubt it's a muni I'd buy, and no way would I hold 10-year maturity AA in the current environment.

And we have to be very careful with our definition of "safe". Everyone thought ultra-short-term bond funds were almost as safe as cash, then 2008 hit, and some had horrendous declines. I actually owned some of one, and fortunately got out as soon as I saw it declining more than expected--it then declined a lot more after that. Even though I own some, I think there's a reason that IL munis consistently offer the highest yields for a given rating--the market is telling us something in the pricing (the bond I mentioned in previous paragraph is an IL bond).

Fidelity fixed income cannot pull a rabbit out of a hat. There is no magic here--you get what the market offers.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Wed May 16, 2018 8:38 pm

Kevin M wrote:
Wed May 16, 2018 7:51 pm
gmaynardkrebs wrote:
Wed May 16, 2018 5:03 pm
Kevin, which Treasuries are you looking at. Can one realistically expect inefficient pricing opportunities in the treasury market? Wouldn’t it have to be more of an intermediation type of situation?
Sorry, I don't understand the question. I don't expect inefficient pricing opportunities in the Treasury market. What did I say that led you to that conclusion?

Kevin
Inefficiencies is the wrong word. Perhaps "opportunities"? By that I mean you seem to find "orphan" munis at good deals, for whatever reasons. That seems plausible with munis, which, can be idiosyncratic/thinly traded/illiquid. Not so plausible with Treasuries, which is probably the most efficiently priced market on earth.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Wed May 16, 2018 9:50 pm

gmaynardkrebs wrote:
Wed May 16, 2018 8:38 pm
Inefficiencies is the wrong word. Perhaps "opportunities"? By that I mean you seem to find "orphan" munis at good deals, for whatever reasons. That seems plausible with munis, which, can be idiosyncratic/thinly traded/illiquid. Not so plausible with Treasuries, which is probably the most efficiently priced market on earth.
Totally agree. Although the "orphan" munis may or may not be good deals--they may just be the market pricing in the risk that's not evident in the ratings, which I assume is why we consistently see IL munis offering higher yields at a given rating (and I now screen out IL munis). Or the quantity offered at a good yield might be only 5 (this is common). I used to buy quantity 5 sometimes, but have decided it's just not worth the extra bookkeeping, so now filter out quantity less than 10.

We can see some of this in this chart, which I built with yields pulled from Fidelity today. All munis are call protected and sinking fund protected, and no housing or hospital munis are included (historically highest default rates). Also, I've filtered to only view munis with quantity greater than 5 and less than 25, since this is the quantity range I'm interested in, and no IL munis are included. I've also done some additional filtering to reduce the number of munis to evaluate, so this is only a sample of the munis that meet the search criteria (about 2,050 met search criteria, but I filtered that down to about 235 that are shown in the chart).

Image

All the munis are rated at least AA2 by Moody's or AA by S&P (so above AA3 or AA-), yet we see large variation of yields at the same maturities, and we would see even larger variations if I included all munis that met the search criteria.

By contrast, the Treasury curve is quite smooth, with only little bumps, which probably are zero-coupon bonds (higher duration at same maturity, so higher yield). However, this is filtered similar to how the munis are filtered, so this is not showing the lower-yielding Treasuries in a given maturity range; if I included those, which are the older higher-coupon bonds with lower duration and lower yields, we also would see some rather large dips in the curve.

Consistent with what I said in earlier replies today, Treasuries offer me higher TEYs than most munis of same maturity, which is why I'm leaning more toward Treasuries now. The exceptions may be good deals, or they may just be the market pricing in extra risk.

Looking at the first obvious "orphan", the 1.66-year at 3.06%, I see it is a NJ school district muni rated AA by S&P with no Moody's rating, and not insured so AA is underlying rating. From just this info, I don't see anything wrong with it, but NJ is one of the states that does tend to offer higher yields. It's CUSIP 405288BT7 if anyone wants to check it out. There were only 10 available when I did the search.

The 2.63-year at 3.32% is a CT muni rated AA by S&P, but only A1 by Moody's. Maybe the A1 rating is what is pulling the price down (yield up). It's CUSIP 207758QF3 if anyone wants to check further. There were 20 available with minimum quantity 5 when I did the search.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Thu May 17, 2018 3:39 pm

Kevin M wrote:
Wed May 16, 2018 9:50 pm
Consistent with what I said in earlier replies today, Treasuries offer me higher TEYs than most munis of same maturity, which is why I'm leaning more toward Treasuries now. The exceptions may be good deals, or they may just be the market pricing in extra risk.

Looking at the first obvious "orphan", the 1.66-year at 3.06%, I see it is a NJ school district muni rated AA by S&P with no Moody's rating, and not insured so AA is underlying rating. From just this info, I don't see anything wrong with it, but NJ is one of the states that does tend to offer higher yields. It's CUSIP 405288BT7 if anyone wants to check it out. There were only 10 available when I did the search.
This was available today at a slightly higher yield, so I bought 10. Here is a little more info on the data and my thinking.

Yield, net yield, and net TEY today were 2.242%, 2.181% and 3.086% respectively. Bond matures 01/15/2020, so this is 1.65-year. There is a Treasury maturing same date at 2.515%, which is TEY for me of 2.825%. This is for minimum quantity 200, so my yield would be a bit lower. Yield on this Treasury has increased to 2.520% since I did my pull, but even so, yield for 10 would be 2.504% with is TEY of 2.812%. So muni provides 27.4 basis points more TEY. I'd have to go to almost 3-year maturity with Treasuries to match the 1.65-year muni TEY.

The AA rating was assigned by S&P on 5/3/2016, and I don't see any rating updates since. In the continuing disclosures, there's a link to a rating downgrade of NJ School Bond Reserve Program from A to A- by S&P as of 11/14/2016, but a note in bold says ISSUER UNDERLYING RATING IS NOT AFFECTED BY THIS CHANGE.

I didn't yet own any NJ munis, so there is no concern about too much concentration in NJ.

Regarding the fairness of the price, I saw a customer buy of 15 earlier today at a net yield of 2.050% (my buy shows as 2.180%, so a smidge different than my calculated value of 2.181%), and I now see another customer buy of 10 at 2.039%. So I got the best price relative to the other two customers who bought today.

Bid/ask spread doesn't really factor into my thinking in terms of price fairness, but for grins, looking at the four related transactions (occurred at exact same time), customer sold at 101.925, there were two dealer to dealer trades at 102.025, and my net price was 102.125, so the bid ask spread was 20 basis points. Half of that was the 0.1% (10 basis points) commission I paid to Fidelity, and perhaps the other half was the commission they charged the seller. This is a much higher bid/ask than for Treasuries, but much lower than the average bid/ask I see for CDs, which is more than 50 basis points.

So, there might be something about this bond that's not reflected in the AA credit rating that's causing the apparently anomalous high yield, but with only 1.65 years to maturity, I'm pretty comfortable with it, and feel like the large yield premium over Treasury of same maturity makes it worth the tiny risk to my overall portfolio.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu May 17, 2018 4:46 pm

Full faith and credit Treasury vs. some NJ school district with no wrap, for 27.4 basis points? What can happen in 1.65 years in NJ? Ever watch the Sopranos? :wink: Ever heard of Chris Christie? Christine Todd Whitman? NJ is the place where things that just don't happen, happen. I think you have Keynes' gambler instinct, and you enjoy this, plus you are smart and diversified. But 27.4 basis points doesn't make sense to me.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Thu May 17, 2018 5:17 pm

gmaynardkrebs wrote:
Thu May 17, 2018 4:46 pm
Full faith and credit Treasury vs. some NJ school district with no wrap, for 27.4 basis points? What can happen in 1.65 years in NJ? Ever watch the Sopranos? :wink: Ever heard of Chris Christie? Christine Todd Whitman? NJ is the place where things that just don't happen, happen. I think you have Keynes' gambler instinct, and you enjoy this, plus you are smart and diversified. But 27.4 basis points doesn't make sense to me.
Fair enough. Then you should stick with Treasuries, and your vote would be for me to stick with Treasuries. As I said, I am leaning more toward Treasuries now, but still will pick up a muni now and then when it looks relatively attractive.

Would be interested in a more analytical critique of the risks of this particular muni that the market might be pricing in. I saw a bit of an article about risks to NJ school districts because of reduced state funding, or something like that, but I would have had to subscribe to see the entire article.

Much of this is a learning and sharing experience, hoping for good critical insights from fellow Bogleheads with muni experience. But hoping for more than anecdotal comments like I received about my IL munis ("So and so said, 'I wouldn't touch IL munis with a 10-foot pole'", or something like that), despite the AAA/AAA ratings of some of those bonds, and the very short terms-to maturity for the AA rated ones (and the rating of one was upgraded shortly after I bought it). The comments about Sopranos et al are along the same lines--they are funny, but not particularly enlightening.

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by puravida » Thu May 17, 2018 5:39 pm

Bond Default Risks - for awareness when choosing muni bonds
Default Rate - 15 yrs to 1994
Corp 1.80%
Municipal Overall 0.16%

Avoid: Ind. Dev. 7.00%
Housing, multifamily 5.00%
Healthcare, nursing 1.60%
Electricity 1.50%

Better: Water/Sewer Rev 0.05%
Schools, Educ. 0.04%
Transp, Highway 0.01%

If interested in taking on risk for higher yield, check out HYD (over 4%)
Simple, passive, effective - the Bogle way...

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu May 17, 2018 6:06 pm

Kevin M wrote:
Thu May 17, 2018 5:17 pm
gmaynardkrebs wrote:
Thu May 17, 2018 4:46 pm
Full faith and credit Treasury vs. some NJ school district with no wrap, for 27.4 basis points? What can happen in 1.65 years in NJ? Ever watch the Sopranos? :wink: Ever heard of Chris Christie? Christine Todd Whitman? NJ is the place where things that just don't happen, happen. I think you have Keynes' gambler instinct, and you enjoy this, plus you are smart and diversified. But 27.4 basis points doesn't make sense to me.
Fair enough. Then you should stick with Treasuries, and your vote would be for me to stick with Treasuries. As I said, I am leaning more toward Treasuries now, but still will pick up a muni now and then when it looks relatively attractive.

Would be interested in a more analytical critique of the risks of this particular muni that the market might be pricing in. I saw a bit of an article about risks to NJ school districts because of reduced state funding, or something like that, but I would have had to subscribe to see the entire article.

Much of this is a learning and sharing experience, hoping for good critical insights from fellow Bogleheads with muni experience. But hoping for more than anecdotal comments like I received about my IL munis ("So and so said, 'I wouldn't touch IL munis with a 10-foot pole'", or something like that), despite the AAA/AAA ratings of some of those bonds, and the very short terms-to maturity for the AA rated ones (and the rating of one was upgraded shortly after I bought it). The comments about Sopranos et al are along the same lines--they are funny, but not particularly enlightening.

Kevin
Always trying for a little humor leaven the discussion, but I think there's a serious point to be made here. It seems to me you focused on the micro side only, and overlooked the macro in this case. At least half of the 27 basis point advantage can be explained by generic credit quality of state vs federal obligations. Then throw in NJ.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Thu May 17, 2018 7:09 pm

Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu May 17, 2018 7:14 pm

ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
Unless one of them defaults.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Thu May 17, 2018 7:23 pm

gmaynardkrebs wrote:
Thu May 17, 2018 7:14 pm
ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
Unless one of them defaults.
I guess I should have included the emphasis in the original.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu May 17, 2018 7:38 pm

ofckrupke wrote:
Thu May 17, 2018 7:23 pm
gmaynardkrebs wrote:
Thu May 17, 2018 7:14 pm
ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
Unless one of them defaults.
I guess I should have included the emphasis in the original.
Does the difference in expected return fully capture the default risk? That’s a question, not a declaration.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Thu May 17, 2018 7:45 pm

gmaynardkrebs wrote:
Thu May 17, 2018 7:38 pm
ofckrupke wrote:
Thu May 17, 2018 7:23 pm
gmaynardkrebs wrote:
Thu May 17, 2018 7:14 pm
ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
Unless one of them defaults.
I guess I should have included the emphasis in the original.
Does the difference in expected return fully capture the default risk? That’s a question, not a declaration.
In an efficient market, yes....in someone's tax regime, anyway, if not in Kevin's.
If the opportunity has dried up then it's plausible that the difference more than fully captures the default risk.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Thu May 17, 2018 8:36 pm

ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
This argument is made all the time, and the answer is always the same.

When you look at dollar amounts for relatively small dollar values, 20 or 30 basis points of extra yield always looks small. Yet a common guideline is to extend maturity only if you can earn at least 20 basis points of extra yield. You get less than that for extending Treasury maturity from 2-year to 3-year, and you only get about 9 bps/year for extending from 3-year to 5-year. So by this reasoning, no one should be holding any Treasuries with maturity of more than two years, yet many are happy to hold Total Bond with lots of Treasuries and duration of about six years.

If you use this reasoning for each year of maturity extension, you might as well just keep all fixed income in a money market fund.

So I could extend Treasury maturity to three years to earn the extra $30, or I can take a little credit risk and keep the term risk at 1.65 years. Term risk is a real thing too.

Multiply this type of decision over many purchases compounded over many years, and 20-30 basis points of extra yield amounts to real money. It's the same principal as keeping your ER low on mutual funds, which seems like a big deal to most Bogleheads.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Thu May 17, 2018 9:09 pm

puravida wrote:
Thu May 17, 2018 5:39 pm
Bond Default Risks - for awareness when choosing muni bonds
Default Rate - 15 yrs to 1994
Corp 1.80%
Municipal Overall 0.16%

Avoid: Ind. Dev. 7.00%
Housing, multifamily 5.00%
Healthcare, nursing 1.60%
Electricity 1.50%

Better: Water/Sewer Rev 0.05%
Schools, Educ. 0.04%
Transp, Highway 0.01%

If interested in taking on risk for higher yield, check out HYD (over 4%)
Thanks for the inputs. The main reference I've been using for muni default risk is Moody's "U.S. Municipal Bond Defaults and Recoveries, 1970-2011", which anyone can find with a web search (might have to sign up for free Moody's account to get it).

From that report, I've already shared that the cumulative 4-year default rate for AA munis was 0.00%, and the 10-year cumulative default rate was 0.01% (that's one bond out of 10,000). Although we should remember that things can happen that haven't happened before, many of our investing decisions are informed by history, evidence of which we frequently see posted here about the virtual certainty of higher long-term returns from stocks.

More stats from that report.

Total muni defaults of Moody's rated munis over the 41-year period was 71. The vast majority were in healthcare (23) and housing (29), which I screen out in my searches. Only three of those defaults were in education.

If I thought it were an absolute no-brainer and a free lunch, I wouldn't bother posting so much about it. I'm interested in informed inputs from anyone who has actual insight into the particular munis about which I share my buying experiences. For those who might happen to see this, but won't bother to look up the bond from the CUSIP, it is HAINESPORT TWP N J SCH DIST SCH BDS 03.50000% 01/15/2020 SER.2010 A&B. Does anyone have any direct knowledge of what's going on in Hainesport Township that might suggest that this bond does not deserve an AA rating, and that there's a realistic risk of default in less than two years?

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by gmaynardkrebs » Thu May 17, 2018 10:21 pm

Water flushing appears to have gone well.

https://www.hainesporttownship.com/home ... g-schedule

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by ofckrupke » Thu May 17, 2018 10:31 pm

Kevin M wrote:
Thu May 17, 2018 8:36 pm
ofckrupke wrote:
Thu May 17, 2018 7:09 pm
Difference in expected return between the two $10k investments over the 1.65 years is thirty bucks, after taxes.
This argument is made all the time, and the answer is always the same.

[...]

Multiply this type of decision over many purchases compounded over many years, and 20-30 basis points of extra yield amounts to real money. It's the same principal as keeping your ER low on mutual funds, which seems like a big deal to most Bogleheads.
Many readers are not so facile with the numbers as to immediately grasp that the scale of the win on each of these anomaly-opportunity exploits is comparable to a breakfast out, or a nice bottle of wine. Clarifying this scale is my only purpose in noting the absolute numbers.

Scaleability and sustainability, for retirement-income enhancement by exploiting muni/brokered-CD anomalies, must be inversely related; in this respect it's quite unlike ER shaving. There will always be forced & discounted small-lot sales, but as time passes their capture by automaton will become more economically feasible - and as other veins for coders run out, they will look more and more like low hanging fruit, and then they will stop showing up on punter displays like ours. Props for documenting your method for others' education though, considering the contribution this might make to its demise before your own.

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Kevin M » Fri May 18, 2018 12:13 pm

ofckrupke wrote:
Thu May 17, 2018 10:31 pm
Scaleability and sustainability, for retirement-income enhancement by exploiting muni/brokered-CD anomalies, must be inversely related; in this respect it's quite unlike ER shaving. There will always be forced & discounted small-lot sales, but as time passes their capture by automaton will become more economically feasible - and as other veins for coders run out, they will look more and more like low hanging fruit, and then they will stop showing up on punter displays like ours.
Interesting perspective.

For some years I was getting 100-150 basis point yield premiums over Treasuries with direct CDs, mostly 5-year maturity. Some were also getting healthy yield premiums, although not quite as large, with brokered CDs. With yield premiums like that, direct CDs were even a good deal in taxable accounts, so no need to look at munis then. I took advantage of that while it lasted, but the game has changed, the yield premiums have shrunk to 20-30 bps in tax-advantaged accounts, and the best values, IMO, are brokered CDs in the 2-3 year maturity range. So now I'll take advantage of that in IRAs while it lasts.

I don't think automation had anything to do with the reduction of the yield premiums--it's more just a change in the fixed-income landscape, and I think it's hard to predict how that landscape will change over time.

If you look at Larry Swedroe's reply (first reply in the thread), he mentions that the OP is an example of what he's been telling people for 20 years. I've also seen him mention the small-lot premiums in the past. Since I'm fairly new at this, I don't know whether the small-lot anomaly will persist, but apparently it has for some time.

And as I've said, if I don't see a muni that looks good to me, I'll probably just add Treasuries to my muni/Treasury ladder as more taxable cash becomes available. So I agree that this particular example may not be an example of something that will add up to much, but I'll continue to pick up an extra 20-30 basis points when I can.
Props for documenting your method for others' education though, considering the contribution this might make to its demise before your own.
Yeah, I've thought about that. I may be creating my own competition by sharing here, but I guess I can't help myself.
:oops:

Kevin
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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by Mrmetalpole » Fri May 18, 2018 8:01 pm

Kevin M wrote:
Wed May 16, 2018 8:17 pm
Mrmetalpole wrote:
Wed May 16, 2018 7:01 pm
Thank you very much for the feedback. Perhaps I’ll share the proposed ideas that Fidelity fixed income claims would safely yield 4-5% via munis if they follow-up as stated. Thanks again,
That would be great.

I can tell you for sure that they are talking either in terms of taxable-equivalent yield or current yield, and even if TEY, you would need to extend maturity to 10 years to get into the 5% ballpark. Current yield is not a good measure of return, so don't get fooled by it. You want to look at yield to maturity, as that incorporates price change from now until maturity as well as interest payments.

If you tell me your marginal federal and state income tax rates, I can show you some yield curves based on those tax rates. At my tax rates, Fidelity summary page shows a 10-year AA muni with TEY of 4.84% (yield of 3.42%), but I doubt it's a muni I'd buy, and no way would I hold 10-year maturity AA in the current environment.

And we have to be very careful with our definition of "safe". Everyone thought ultra-short-term bond funds were almost as safe as cash, then 2008 hit, and some had horrendous declines. I actually owned some of one, and fortunately got out as soon as I saw it declining more than expected--it then declined a lot more after that. Even though I own some, I think there's a reason that IL munis consistently offer the highest yields for a given rating--the market is telling us something in the pricing (the bond I mentioned in previous paragraph is an IL bond).

Fidelity fixed income cannot pull a rabbit out of a hat. There is no magic here--you get what the market offers.

Kevin
Hi Kevin, the YTM on the muni options presented to me range from 1.89-2.34, ranging in maturity from 6/20-6/24. Examples below, several more in the proposal I received. The fixed income Fidelity colleague made it seem that this is an easy way to generate a 4-5% passive income on my principal as they can pick the munis and invest for me with no fees. Thanks for your info and perspective.

25476FRW0 DISTRICT COLUMBIA GO BDS SER.2016 A DC AA1/ AA1 AA 5.000 06/01/2020 106.190 1.890 1.890 4.710 Non-Callable N N 1.90
899656QC9 TULSA OKLA MET UTIL AUTH UTIL REV UTIL OK AA1/ AA1 AA+ 5.000 10/01/2020 107.120 1.910 1.910 4.670 Callable N N 2.23
419792JW7 HAWAII ST GO REF BDS SER. FE HI AA1/ AA1 AA+ 5.000 10/01/2020 107.100 1.920 1.920 4.670 Non-Callable N N 2.23
604129YH3 MINNESOTA ST GO ST TRUNK HWY BDS SER. MN AA1/ AA1 AA+ 5.000 10/01/2020 107.090 1.920 1.920 4.670 Non-Callable N N 2.23
49474FDL1 KING CNTY WASH LTD TAX GO REF BDS SER. WA AAA/ AAA AAA 5.000 12/01/2020 107.585 1.920 1.920 4.650 Non-Callable N N 2.35
0793652N1 BELLEVUE WASH LTD TAX REF BDS SER. WA AAA/ AAA AAA 5.000 12/01/2020 107.690 1.880 1.880 4.640 Non-Callable N N 2.35
949238CP2 WELD CNTY COLO SCH DIST NO RE-001 GO CO AA2/ A3 AA 5.000 12/15/2020 107.722 1.910 1.910 4.640 Non-Callable N Y 2.38
041042UL4 ARKANSAS ST GO GRNT ANTIC AND TAX REV AR AA1/ AA1 AA 5.000 04/01/2021 108.420 1.970 1.970 4.610 Non-Callable N N 2.67
736688HY1 PORTLAND ORE CMNTY COLLEGE DIST GO BDS OR AA1/ AA1 AA+ 5.000 06/15/2021 109.027 1.960 1.960 4.590 Non-Callable N N 2.82

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Re: 2-year AA Munis at Vanguard and Fidelity Today

Post by AerialWombat » Fri Aug 10, 2018 1:17 pm

Kevin M wrote:
Thu Apr 12, 2018 4:38 pm
I just resumed buying munis in taxable after liquidating some no-penalty CDs at Ally, and thought I would share what I bought today and why.
Just wanted to post a "Thank You" to Kevin for directing me to this thread from the one I started. Wealth of information here! :sharebeer

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