Investing in munis (versus Total Bond Market Fund)

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Topic Author
FIPreferred
Posts: 3
Joined: Fri Nov 29, 2019 2:27 pm

Investing in munis (versus Total Bond Market Fund)

Post by FIPreferred » Fri Nov 29, 2019 3:30 pm

First post, and I know this has probably been asked to death, but could use someone to check my thinking!

We are PA residents, MFJ, and currently in the 35% Federal Tax brackets with a 3.07% state income tax. Have been following a plan to have roughly consistent asset allocation in both taxable and retirement/tax-advantaged.

Currently underweight bonds in the taxable portion of our assets (total is mid 7 figures) and sitting on a bunch of cash currently. Current bond portfolio looks like:

VBTLX Total Bond Market Index: $245K
VMLUX Limited-Term Tax-Exempt: $105K
VPALX Pennsylvania Long-Term Tax-Exempt: $62K
VWIUX Intermediate-Term Tax-Exempt: $58K
------------------------------------------------------
Total fixed income: $470K

Cash: $290K

I realize that VBTLX is probably not the best TEY yield, but have about $18K in capital gains if I were to sell out of it. I assume at my marginal tax rate in general the munis are the way to go?

In seeking answers, I came across Kevin M and retiringwhen's really helpful posts. In my quest for a lazy solution, I hacked up retiringwhen's MM yield calculator to see if I could shortcut an answer. See link to my results here. I've probably screwed up the calculation somewhere, but it seems like PA LT Tax-Exempt (3.7% TEY) out-performs VBTLX (2.3%) significantly while having a similar duration (6.3 vs. 6.2 yrs).

Couple of questions:
1) What did I screw up in the calculation (I'm sure I did somewhere!)
2) How should I think about a framework to create a diversified bond portfolio? How important is balance across Short/Medium/Long duration exposure?
3) How would you suggest I invest the $290K currently allocated for bonds? Given the apparent TEY advantage of VPALX to all others, should I just pile in there and/or create a barbell strategy with VPALX & VMLUX?
4) Does my plan of having similar asset allocations in taxable/tax-advantaged still make sense? I know its more tax efficient to have all bonds in tax-advantaged, but was going for simplicity and creating some additional room in tax advantaged by holding equities.

Any input greatly appreciated!
Last edited by FIPreferred on Sun Dec 01, 2019 8:37 pm, edited 2 times in total.

kevinf
Posts: 78
Joined: Mon Aug 05, 2019 11:35 pm

Re: Investing in bonds / munis (PA resident)

Post by kevinf » Fri Nov 29, 2019 5:46 pm

PA resident here, in a lower tax bracket. When I ran the numbers for myself, the PA muni was extremely competitive with most taxable bonds when using TEY, as in within .01% excepting the corporate bonds and high volatility bonds. You probably aren't missing anything.

I'm using VPAIX as storage as I accrue "excess" funds that pass my high yield checking account limit, and just move anything I need short term (1 to 12 months) to the PA Municipal Money Market (VPTXX). Both of these funds are in my taxable brokerage account.

hudson
Posts: 2042
Joined: Fri Apr 06, 2007 9:15 am

Re: Investing in bonds / munis (PA resident)

Post by hudson » Fri Nov 29, 2019 8:22 pm

FIPreferred wrote:
Fri Nov 29, 2019 3:30 pm
How would you suggest I invest the $290K currently allocated for bonds? Given the apparent TEY advantage of VPALX to all others, should I just pile in there and/or create a barbell strategy with VPALX & VMLUX?
I see that you are hoping to avoid paying state tax.
If I lived in PA, I would likely go half VPAIX and half Vang. National Intermed Muni VWIUX.
Nuveen's expense ratio is too high at .43 for me.
When I look at bond funds, I want intermediate, a high percentage of AAA/AA/A bonds, a low ER, a good SEC yield, and a good distribution yield. I want Vanguard Risk Potential 1 or 2.
VPAIX is Vanguard Risk Potential 3 because long bonds are riskier then shorter duration bonds.

Topic Author
FIPreferred
Posts: 3
Joined: Fri Nov 29, 2019 2:27 pm

Re: Investing in bonds / munis (PA resident)

Post by FIPreferred » Sun Dec 01, 2019 8:36 pm

Thanks all, very helpful. So not really a big deal to think about building diversification on duration of funds? I searched quite a bit on the forum and didn't find much. Perhaps thats telling in itself?

kevinf
Posts: 78
Joined: Mon Aug 05, 2019 11:35 pm

Re: Investing in munis (versus Total Bond Market Fund)

Post by kevinf » Sun Dec 01, 2019 9:46 pm

It may be helpful to know why you are holding bonds. If they are just there for a long-term portfolio volatility hedge, then as long as the yield is keeping pace with inflation that seems like a win. The only bond funds that yield significantly better than the PA muni tend to be extremely volatile or in the case of corporate bonds, strongly correlated to equity performance, which costs you your volatility hedge.

Between a portfolio of index stock funds and 50/50 PA muni / Indexed muni, you seem well diversified already. Most typical bond funds shouldn't be incredibly volatile in and of themselves which is probably why you aren't finding much on diversifying a bond fund. For just hedging against state risk (though I don't consider the PA muni particularly risky) the index muni should cover that. With how much you have in bonds, you're probably keeping them long-term, so I don't think the long-term bonds are problematic for you versus someone who's trying to use them as a cash equivalent.

There are people that would give better bond advice here though, maybe they'll chime in.

Topic Author
FIPreferred
Posts: 3
Joined: Fri Nov 29, 2019 2:27 pm

Re: Investing in munis (versus Total Bond Market Fund)

Post by FIPreferred » Thu Dec 05, 2019 12:37 pm

Thanks Kevin, and yes mostly for volitility hedge, not as much for current income.

Your response is really helpful, definitely makes a lot of sense.

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