Muni bond fund in taxable account: state (CA) or national

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petrisunset
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Muni bond fund in taxable account: state (CA) or national

Post by petrisunset » Mon Mar 18, 2019 11:24 pm

Hi BH,

I need to hold some bonds in my taxable account to keep my AA. Those of you who are in a similar situation: Are you holding a state issued muni bond fund a national one? What would be your advise for someone who hast to start adding a muni bond fund to an existing three fund portfolio. I live in California.
Thank you very much.

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Clever_Username
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Re: Muni bond fund in taxable account: state (CA) or national

Post by Clever_Username » Mon Mar 18, 2019 11:48 pm

I went with a CA specific fund. I'm in the 9.x% bracket in CA, 32% federal.

I got good advice in this thread: viewtopic.php?f=1&t=228622

and I do not believe my situation has changed much, other than my bracket has gone up.
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michaeljmroger
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Re: Muni bond fund in taxable account: state (CA) or national

Post by michaeljmroger » Mon Mar 18, 2019 11:51 pm

I wouldn’t recommend holding only CA bonds if you had a lot of munis, but if you’re just getting started and you have a fairly long investing horizon and you’re in a high tax bracket then yes, it’s totally fine to go with a CA bond fund.

mega317
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Re: Muni bond fund in taxable account: state (CA) or national

Post by mega317 » Tue Mar 19, 2019 1:27 am

At the 9.3% bracket the after-tax yields are almost identical at least at the moment. People like to use TEY but after tax you're looking at 2.03% vs. 1.98%. 5 bucks per $10,000.

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Cyclesafe
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Re: Muni bond fund in taxable account: state (CA) or national

Post by Cyclesafe » Tue Mar 19, 2019 7:56 am

Choice here is all about risk if tax equivalent yield happens to be the same. Cali has the 5th largest economy in the world - between UK and Germany - and its bonds thus probably safer than those from an average non-Cali US state.

Previous threads have offered 50% Cali / 50% non-Cali as a compromise, but I have never seen any analysis of why this might be valid. Why not 60-70%, for example.

One reason I can think of to argue for a zero Cali muni portion, assuming identical TEY, (in practice, however, there will always be 13-15% Cali in a national muni) is that the 9.3% Cali bracket goes so high (AGI above $551k, 2019 MFJ) that I would gladly fund my state with interest earned from non-Cali state obligations as long as the bottom line is the same either way for me.

If I am not alone in this thinking, does this imply that national muni's are indeed of higher RISK than Cali's alone?
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Re: Muni bond fund in taxable account: state (CA) or national

Post by mega317 » Tue Mar 19, 2019 8:22 am

I don't really know how to evaluate risk of an individual state but California has had defaults in my recent memory. Does the size of an economy correlate with default risk?

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Re: Muni bond fund in taxable account: state (CA) or national

Post by MikeG62 » Tue Mar 19, 2019 8:46 am

michaeljmroger wrote:
Mon Mar 18, 2019 11:51 pm
I wouldn’t recommend holding only CA bonds if you had a lot of munis, but if you’re just getting started and you have a fairly long investing horizon and you’re in a high tax bracket then yes, it’s totally fine to go with a CA bond fund.
Agree with this advice.

Sounds like OP is just starting out with Muni’s so probably fine to go with CA only muni’s for a while.
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petrisunset
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Re: Muni bond fund in taxable account: state (CA) or national

Post by petrisunset » Wed Mar 20, 2019 1:21 pm

Thanks a lot for all your valuable comments. I'll go with the National Muni fund. Beside the broader diversification across all states vs. CA alone it also has a slighly lower E/R (0.17 National Muni vs 0.19 for the CA Muni). So this will off-set a little bit the state-tax, which will be marginal anyway, as the big chunk of my bond holdings are be in my 401(k).

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Re: Muni bond fund in taxable account: state (CA) or national

Post by grabiner » Wed Mar 20, 2019 9:25 pm

My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt. This gives you only half your bonds in CA, and an overall intermediate-term duration, but more than half your income exempt from CA tax.

However, if the muni fund is only a small part of your portfolio (because you also hold a bond fund in your 401(k) or IRA), then all-CA is reasonable, as you have diversified the risk with your other bond holdings.
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Re: Muni bond fund in taxable account: state (CA) or national

Post by Clever_Username » Thu Mar 21, 2019 12:51 pm

grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt. This gives you only half your bonds in CA, and an overall intermediate-term duration, but more than half your income exempt from CA tax.

However, if the muni fund is only a small part of your portfolio (because you also hold a bond fund in your 401(k) or IRA), then all-CA is reasonable, as you have diversified the risk with your other bond holdings.

How small do you consider for this? My muni bond holdings (all CA intermed. term) is about 11% of my portfolio, less than half my bonds. I'm barely in Admiral shares (not that this should decide which I choose), and if I split, I wouldn't be in for either. Fortunately, my accumulated cap gains are sufficiently small in the fund (I think it's tens of dollars) that I can easily make the change if you think I should.
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Re: Muni bond fund in taxable account: state (CA) or national

Post by grabiner » Thu Mar 21, 2019 7:37 pm

Clever_Username wrote:
Thu Mar 21, 2019 12:51 pm
grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt. This gives you only half your bonds in CA, and an overall intermediate-term duration, but more than half your income exempt from CA tax.

However, if the muni fund is only a small part of your portfolio (because you also hold a bond fund in your 401(k) or IRA), then all-CA is reasonable, as you have diversified the risk with your other bond holdings.

How small do you consider for this? My muni bond holdings (all CA intermed. term) is about 11% of my portfolio, less than half my bonds.
If it is less than half your bonds, then using only the CA fund is probably right. My own recommendation above is to hold half your bonds in CA if all your bonds are in your taxable account.

Note that I don't have personal experience here; I live in a high-tax state with no low-cost muni fund (MD) and hold all my bonds in my employer plan.
Wiki David Grabiner

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Re: Muni bond fund in taxable account: state (CA) or national

Post by Clever_Username » Fri Mar 22, 2019 12:27 am

grabiner wrote:
Thu Mar 21, 2019 7:37 pm
Clever_Username wrote:
Thu Mar 21, 2019 12:51 pm
grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt. This gives you only half your bonds in CA, and an overall intermediate-term duration, but more than half your income exempt from CA tax.

However, if the muni fund is only a small part of your portfolio (because you also hold a bond fund in your 401(k) or IRA), then all-CA is reasonable, as you have diversified the risk with your other bond holdings.

How small do you consider for this? My muni bond holdings (all CA intermed. term) is about 11% of my portfolio, less than half my bonds.
If it is less than half your bonds, then using only the CA fund is probably right. My own recommendation above is to hold half your bonds in CA if all your bonds are in your taxable account.

Note that I don't have personal experience here; I live in a high-tax state with no low-cost muni fund (MD) and hold all my bonds in my employer plan.
Thank you for the information. I always appreciate the analysis you are able to provide.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by yeahman » Fri Mar 22, 2019 2:01 am

grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt.
What's the reason for that over intermediate term for both?

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Re: Muni bond fund in taxable account: state (CA) or national

Post by ivk5 » Fri Mar 22, 2019 2:27 am

yeahman wrote:
Fri Mar 22, 2019 2:01 am
grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt.
What's the reason for that over intermediate term for both?
I’m not grabiner but I think the idea is that more that half of the yield is state tax free without exposing more than half of the yield to single-state concentration risk.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by unclescrooge » Fri Mar 22, 2019 6:54 am

ivk5 wrote:
Fri Mar 22, 2019 2:27 am
yeahman wrote:
Fri Mar 22, 2019 2:01 am
grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt.
What's the reason for that over intermediate term for both?
I’m not grabiner but I think the idea is that more that half of the yield is state tax free without exposing more than half of the yield to single-state concentration risk.
I think the question was more about long term vs intermediate bonds, and less about national vs state munies.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by stan1 » Fri Mar 22, 2019 7:11 am

The average duration on CA Intermediate and Long Term is not that different:

CA Intermediate Investor: 5.2 year average duration, 30 day SEC yield 2.02%
CA Long Term Investor: 7.0 year average duration, 30 day SEC yield 2.49%

In contrast the average duration of Long Term Treasury is 17 years. Very different investments, yes, but the point is to show that the average duration of the CA Long Term fund is close to the duration of CA Intermediate term with higher yield. This has persisted for many years.

On this board CA residents tend to be more comfortable with a higher percentage of their portfolio in CA muni bonds than non-CA residents. As a CA resident if I was in the 9.3% marginal tax rate or higher I would put up to 20% of my portfolio into CA muni bond funds with no concerns. If I planned to put more than 30% of my total portfolio into CA muni bonds I would diversify into national munis and treasury bonds.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by EvanRude » Fri Mar 22, 2019 9:22 am

To the question of whether CA munis are safer than national - this depends on whether you think that once the "big one" hits and CA is geographically split from the mainland whether it is CA or the mainland that will sink. (Sorry!)

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Re: Muni bond fund in taxable account: state (CA) or national

Post by yeahman » Fri Mar 22, 2019 9:24 am

Anybody come up with a somewhat more objective way to arrive at an allocation? My thinking is that if your state had a 100% tax on bond returns, you'd want to put 100% of your taxable bonds into in-state munis. If your state had no tax on bond returns, you'd want to put 100% into national munis. So if your state tax rate is 9%, you should put 9% of your taxable bonds into in-state and the rest into national. Reasonable?

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Re: Muni bond fund in taxable account: state (CA) or national

Post by ivk5 » Fri Mar 22, 2019 9:59 am

yeahman wrote:
Fri Mar 22, 2019 9:24 am
Anybody come up with a somewhat more objective way to arrive at an allocation? My thinking is that if your state had a 100% tax on bond returns, you'd want to put 100% of your taxable bonds into in-state munis. If your state had no tax on bond returns, you'd want to put 100% into national munis. So if your state tax rate is 9%, you should put 9% of your taxable bonds into in-state and the rest into national. Reasonable?
I don't yet understand the thinking behind the proposed math quoted above.

If state munis have higher tax equivalent yield for you at equivalent duration, then you would want as much of your fixed income allocation in state munis as you can tolerate from credit risk / concentration risk perspective. Hence the discussion upthread ranging from 100% munis for small/moderate allocations to 50/50 for a finger-in-the-air diversification esp of larger allocation.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by yeahman » Fri Mar 22, 2019 10:45 am

ivk5 wrote:
Fri Mar 22, 2019 9:59 am
you would want as much of your fixed income allocation in state munis as you can tolerate from credit risk / concentration risk perspective.
There no way for that to be anything more than pure gut feeling unless you take some actual numbers into account. Otherwise, you also have to consider holding munis in tax protected accounts too if the yields are higher but nobody's seriously considering that. In fact, you would also have to consider chasing the single highest yielding bond.

My idea is to ignore sector/state specific yields and instead to own the market but that tax savings can pay for some additional risk. So we should be looking be at tax rates, not yields, in determining an allocation.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by grabiner » Fri Mar 22, 2019 6:02 pm

unclescrooge wrote:
Fri Mar 22, 2019 6:54 am
ivk5 wrote:
Fri Mar 22, 2019 2:27 am
yeahman wrote:
Fri Mar 22, 2019 2:01 am
grabiner wrote:
Wed Mar 20, 2019 9:25 pm
My normal recommendation here is to hold half your bonds in Vanguard Limited-Term Tax-Exempt, and half in CA Long-Term Tax-Exempt.
What's the reason for that over intermediate term for both?
I’m not grabiner but I think the idea is that more that half of the yield is state tax free without exposing more than half of the yield to single-state concentration risk.
I think the question was more about long term vs intermediate bonds, and less about national vs state munies.
Half long and half short averages to intermediate-term, so either strategy gives you an intermediate-term duration, but my recommendation is better for taxes.
stan1 wrote:
Fri Mar 22, 2019 7:11 am
The average duration on CA Intermediate and Long Term is not that different:

CA Intermediate Investor: 5.2 year average duration, 30 day SEC yield 2.02%
CA Long Term Investor: 7.0 year average duration, 30 day SEC yield 2.49%
This is not quite the risk difference. Most long-term munis are callable, and thus the duration of CA Long-Term will increase more than the duration of CA Intermediate-Term if rates rise. This is an asymmetrical risk, which explains the yield spread.
Wiki David Grabiner

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Re: Muni bond fund in taxable account: state (CA) or national

Post by Artsdoctor » Fri Mar 22, 2019 8:43 pm

petrisunset wrote:
Wed Mar 20, 2019 1:21 pm
Thanks a lot for all your valuable comments. I'll go with the National Muni fund. Beside the broader diversification across all states vs. CA alone it also has a slighly lower E/R (0.17 National Muni vs 0.19 for the CA Muni). So this will off-set a little bit the state-tax, which will be marginal anyway, as the big chunk of my bond holdings are be in my 401(k).
Just to remember, you're taxed on the distribution yield, not the SEC yield. Sometimes those numbers are similar but the distribution yields have been higher than the SEC yields for several years now.

The yield that you're seeing takes the ER into consideration so you don't have to try and compare 17 versus 19 bps.

You'll also want to take a look at the number of bonds in the fund. The CA fund has thousands, whereas most of the other state-specific funds have hundreds, so blanket advice regarding state-specific funds should factor that in.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by pasadena » Fri Mar 22, 2019 8:56 pm

My IPS states that, if the math works in their favor, tax-advantaged bonds should not be more than 50% of the total bond holdings, and state-specific munis should not be more than 50% of tax-advantaged bonds. I wrote that when I was living in CA.

Why? Diversification (in geography but also types of holdings), and it makes me feel better. CA funds do have more holdings than other states, and a good economy, but it does have its own sets of problems - mostly its debt level (especially when it also has high taxes and some of the most profitable companies), earthquakes and other natural disasters.
petrisunset wrote:
Wed Mar 20, 2019 1:21 pm
Thanks a lot for all your valuable comments. I'll go with the National Muni fund. Beside the broader diversification across all states vs. CA alone it also has a slighly lower E/R (0.17 National Muni vs 0.19 for the CA Muni). So this will off-set a little bit the state-tax, which will be marginal anyway, as the big chunk of my bond holdings are be in my 401(k).
Remember that the national muni funds do contain some CA bonds, and that part is tax-free in CA. Every year, Vuanguard publishes a PDF with the ratio of holdings per state in each fund. You need to look at it to know how much of your dividends you can deduct from your state taxes. If I remember correctly, VWITX has around 11% of CA ?

Edit: wrong!
Last edited by pasadena on Fri Mar 22, 2019 9:11 pm, edited 1 time in total.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by mega317 » Fri Mar 22, 2019 9:04 pm

Pasadena I hope you don't follow this advice. In California you can only deduct if at least half of a fund's income is from California.

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Re: Muni bond fund in taxable account: state (CA) or national

Post by pasadena » Fri Mar 22, 2019 9:12 pm

mega317 wrote:
Fri Mar 22, 2019 9:04 pm
Pasadena I hope you don't follow this advice. In California you can only deduct if at least half of a fund's income is from California.
Ah yes, right. I just double checked my last CA return and while TurboTax asks the question, it's not reported ion the return. Thanks for the correction!

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