Tax-Exempt Bond Funds are said to be no-brainers, but are they?

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simplesauce
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Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by simplesauce » Wed Mar 25, 2020 10:00 am

In almost every passive investing book I have read (Bogle, Malkiel, Ferri, etc) they have taught that in your taxable accounts, you should use an intermediate municipal (tax-exempt) bond fund (depending on your tax bracket.)

This has been expressed as very “matter of fact.” However I do not recall any of them discussing the extra volatility one may experience. Is this something we should factor into the equation when deciding on our taxable asset allocation? I have not heard it discussed in these books.

Incidentally, is there a “taxable” bond fund that would be more appropriate in a taxable account for the risk-averse investor? Intermediate treasury fund? Short-term corporate bond fund?

Thank you.

am
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by am » Wed Mar 25, 2020 10:12 am

Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D

Blue456
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by Blue456 » Wed Mar 25, 2020 10:56 am

am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.

am
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by am » Wed Mar 25, 2020 11:15 am

Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
I thought fed was buying unlimited debt to keep markets liquid. It’s a crazy idea that the debtor can buy their own debt?

Blue456
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by Blue456 » Wed Mar 25, 2020 11:27 am

am wrote:
Wed Mar 25, 2020 11:15 am
Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
I thought fed was buying unlimited debt to keep markets liquid. It’s a crazy idea that the debtor can buy their own debt?
I mean they are going to fix it. But cash is king.

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mrspock
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by mrspock » Wed Mar 25, 2020 11:32 am

am wrote:
Wed Mar 25, 2020 11:15 am
Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
I thought fed was buying unlimited debt to keep markets liquid. It’s a crazy idea that the debtor can buy their own debt?
It’s not when the debtor owns the currency printing presses. What’s crazy is that anyone would lend to such a debtor at such low rates :) .

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timboktoo
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by timboktoo » Wed Mar 25, 2020 11:47 am

I think you make an excellent point. When we talk about investing, we probably ought to provide a more complete picture, rather than just catering to our own preferences.

To say that a portfolio is better one way or another, either because the math supports it (requiring a mastery of human character) or because our affinity for ensuring good behavior supports it (an assumption on our part that no human beings can master their character) is incomplete.

I have noticed that almost nobody talks about the cons for any approaches they teach. It is as if we want to gloss over the negatives to our approaches, because we see the alternatives as being so obviously wicked by comparison. In the work world, I've seen that turn into a repetition of history. We seem to make choices based on the pains of our current experience, but without being honest about the new pains our new choices will bring about. We continue to make opposite choices, trying to erase all cons. But the cons are always there.

- Tim

azanon
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by azanon » Wed Mar 25, 2020 11:51 am

I thought it was the other way around TBH, unless you're in, say, the top tax bracket. Meaning, taxable bonds - tax still usually equals more money than tax Exempt, esp with today's lower rates. And treasuries are inherently exempt from state tax. Tax Exempt are niche products for rich people.

CFM300
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by CFM300 » Wed Mar 25, 2020 12:03 pm

simplesauce wrote:
Wed Mar 25, 2020 10:00 am
In almost every passive investing book I have read (Bogle, Malkiel, Ferri, etc) they have taught that in your taxable accounts, you should use an intermediate municipal (tax-exempt) bond fund (depending on your tax bracket.)
David Swensen in Unconventional Success argues against munis, except perhaps for short-term money market investments.

I'm currently rereading Bernstein's "The Four Pillars of Investing." He writes:

"My advice is to split your taxable accounts among all three of the above bond classes (municipal, Treasury, and corporate), if you have enough assets to do so. The Treasuries will usually have a lower after-tax yield, but have the advantages of being perfectly safe and liquid, and free from state tax. Quite frankly, the yield differences aren’t enough to be continually fretting over."

He also states, "I’d buy whatever Treasuries you want directly. (Remember, there is no need for diversification here.) I’d use the Vanguard Short-Term Corporate Fund (or the GNMA fund, which has a higher yield, but a longer maturity) for the non-Treasury part of your bond allocation—you’ll get off cheaper, plus you’ll have more control of your portfolio."

Early in the same section, he mentioned using the Vanguard Limited-Term Tax-Exempt Fund for munis.

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timboktoo
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by timboktoo » Wed Mar 25, 2020 12:15 pm

simplesauce wrote:
Wed Mar 25, 2020 10:00 am
Incidentally, is there a “taxable” bond fund that would be more appropriate in a taxable account for the risk-averse investor? Intermediate treasury fund? Short-term corporate bond fund?
I don't think that there's a rule that always works. At any given time, one fund may deliver a higher after-tax return for you than another in your tax bracket and in your state. Additionally, one fund may, as you've discovered, be more volatile than another.

If you are more comfortable with treasuries, then an intermediate or short-term treasury fund is fine to hold in taxable, assuming you have already maxed out your tax-advantaged space and need to add bonds to taxable to maintain your desired asset allocation. Treasuries are exempt from state taxes. So, there is some small incentive to hold them in taxable over corporate bonds.

Just be aware that you will have to make a trade off regardless of what route you go. If you go with treasuries, you'll have to accept the possibility that municipal bonds might have awarded you with a higher after-tax return. If you go with municipals, you'll have to accept an increased risk of default as well as the potential for increased volatility. In both situations, you'll have to accept interest rate risk.

- Tim

hudson
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by hudson » Wed Mar 25, 2020 1:15 pm

simplesauce wrote:
Wed Mar 25, 2020 10:00 am
In almost every passive investing book I have read (Bogle, Malkiel, Ferri, etc) they have taught that in your taxable accounts, you should use an intermediate municipal (tax-exempt) bond fund (depending on your tax bracket.)

This has been expressed as very “matter of fact.” However I do not recall any of them discussing the extra volatility one may experience. Is this something we should factor into the equation when deciding on our taxable asset allocation? I have not heard it discussed in these books.

Incidentally, is there a “taxable” bond fund that would be more appropriate in a taxable account for the risk-averse investor? Intermediate treasury fund? Short-term corporate bond fund?

Thank you.
If we didn't already know, we now know that munis can drop during times of panic. I think the 3 authors listed above already knew that. Larry Swedroe in The Only Guide to a Winning Bond Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today recommended only AAA/AA munis... which survived the Great Depression with well under 1% losses. William Bernstein in the Ages of the Investor recommended only "TIPS, plain vanilla Treasuries, and CDs" in his Liability Matching Portfolio.

For the safest muni fund: Baird's intermediate BMBIX...almost 100% AAA/AA munis. Did it's price drop? Yes. But safety wise, it would be listed just behind treasuries. BMBIX is 70 times smaller than Vanguard's VWIUX, but it's 2 notches safer.
Last edited by hudson on Wed Mar 25, 2020 4:35 pm, edited 2 times in total.

MarkBarb
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by MarkBarb » Wed Mar 25, 2020 1:19 pm

am wrote:
Wed Mar 25, 2020 11:15 am
Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
I thought fed was buying unlimited debt to keep markets liquid. It’s a crazy idea that the debtor can buy their own debt?
Any debtor can by their own debt. Companies with callable bonds do it. Even those without callable bonds sometimes do it to retire the debt. What makes the treasury special is that they can magically create the money that they use to buy their debt. Of course, they are constrained by the fear of inflation, but there isn't much of that right now.

Call_Me_Op
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by Call_Me_Op » Wed Mar 25, 2020 1:51 pm

Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
Say what? Never heard of such a thing. If that were happening on a broad basis, interest rates would spike.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Phineas J. Whoopee
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by Phineas J. Whoopee » Wed Mar 25, 2020 8:01 pm

The decision about investing in municipal bonds, directly or through a fund, and a fund is usually better because the fund can negotiate narrower spreads, depends on one's federal and state tax bracket. For some Adjusted Gross Incomes a municipal bond will yield more, after tax, and for lower ones a nominal bond will yield more, after tax. There will be a point where it's more or less the same.
PJW

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Phineas J. Whoopee
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Re: Tax-Exempt Bond Funds are said to be no-brainers, but are they?

Post by Phineas J. Whoopee » Wed Mar 25, 2020 8:06 pm

am wrote:
Wed Mar 25, 2020 11:15 am
Blue456 wrote:
Wed Mar 25, 2020 10:56 am
am wrote:
Wed Mar 25, 2020 10:12 am
Treasuries safer than munis as we have seen in this crisis. My int muni fund has fallen about 8% this year although gaining ground this week. Treasury debt belongs to money printers while munis belong to tax collectors. What would you rather own in a crisis? :D
Treasuries have issues too. There is a guy in here who can’t sell 25K of treasuries. Nobody is buying.
I thought fed was buying unlimited debt to keep markets liquid. It’s a crazy idea that the debtor can buy their own debt?
To begin with, the Fed, the Federal Reserve System, does not issue Treasury bills, notes, or bonds. They conduct the auctions as a service, but the US Treasury issues them. The Fed can't possibly buy its own debt in Treasuries, because they're not its debt.

To end with, there is no problem at all with any entity buying its own debt on the open market.

PJW

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