Total bond vs Int tax exempt

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Total bond vs Int tax exempt

Post by vchiu25 »

trying to understand the benefits and risk of switching my bond from total bond to int tax exempt.

Half of my bond is in 401k and is total bond. The other half in taxable, that’s the part I’m thinking about switching

My current assessment is as follows. Did I miss anything? I don’t know if the higher yield is that significant but diversification sounds nice, I’m just worry I might be taking on more risk

Benefits: 0.2% higher yield (32%bracket), diversification
Risk: muni concentration risk
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Re: Total bond vs Int tax exempt

Post by SnowBog »

vchiu25 wrote: Fri May 13, 2022 9:24 pm int tax exempt.
Assuming int = international, I've never heard of an "international" tax exempt fund...

There are "tax exempt" funds - but those are domestic funds.

The benefits of such are entirely dependent on your taxes (including state and local). As s general rule, tax-exempt funds will have a lower dividend.

If you are in a high tax bracket, especially if you are in a high tax state buying a state exempt fund, the "tax equivalent yield" might be higher. When it is - they you have a better "after tax" return.

But if you are in a low tax state, then you'll end up with a lower return...

As for diversification - I'm not sure that would be a driver for me... In theory, tax-exempt bonds are lower risk - since they see backed by government agency's who have the ability to raise taxes to pay the bonds. But at we saw with the pandemic, governments are also exposed to unique risks. For me - I can that a wash...

For what it's worth, I also have my bonds split between tax-deferred and taxable. I use I & EE Savings Bonds - which are exempt from state taxes and federal taxes can be deferred until sold (or up to 30 years). For the rest of my bonds, I use tax-exempt bonds - split roughly 50% state bonds (exempt from both state and federal taxes) and 50% national. I even use a tax-exempt money market fund for my "checking" account.
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Re: Total bond vs Int tax exempt

Post by mega317 »

Probaby int = intermediate.
For diversification, total bond is plenty diversified and I don't think you gain anything adding munis for that specific reason.
VWIUX has a shorter duration and slightly worse average credit quality (to my eye) so it's probably in the same ballpark risk-wise as total bond. Given you will have some of each, that seems diversified enough for me. Or rather, close enough in risk to having all total bond.
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Re: Total bond vs Int tax exempt

Post by grabiner »

I would use munis for the taxable portion of a bond holding in the 32% bracket. You pay 35.8% tax on taxable bond interest (including Net Investment Income Tax), and at that high a tax rate, you expect a higher after-tax yield on bonds of comparable risk.

My rule of thumb is that the break-even rate is 25%, so that taxable bonds yielding 4% and munis yielding 3% have comparable risk levels. Thus, if you want the same risk level on munis versus taxable bonds, you can choose an appropriate combination of funds which have this ratio of yields. Alternatively, you can use a similar fund (Total Bond Market versus Intermediate-Term Tax-Exempt) and just accept that you may be slightly increasing or decreasing your risk but will be compensated for that.
Wiki David Grabiner
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