Muni bonds and taxes

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drbenjamin
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Joined: Thu Sep 13, 2012 10:56 pm

Muni bonds and taxes

Post by drbenjamin »

All
Have done some tax loss harvesting on my BND holdings and am trying to learn more about bond investing in general before putting those funds back into bonds. I am in the 35% bracket, and have been thinking about incorporating some muni funds into my bond portfolio to reduce taxes. Simple enough, but I live in a state with no income tax but a capital gains tax. So, short term capital gains are worse from a tax perspective than ordinary income.
My question relates to a (distant?) future when interest rates start to fall. As I understand it, the price of issued bonds (like those held in bond funds) will go up until their overall yield matches that of newly issued bonds. While the overall yield is the same, doesn't the price increase represent a capital gain? What I'm wondering is whether my goal of lower taxes with a muni fund will be undermined in a time of lowering interest rates by sizeable capital gains distributions by the fund. For example, I see that last year VWALX had 25% of its distributions as capital gains. Would this go up if interest rates dropped? Are there funds that avoid cap gain distributions?

Much appreciated! This bond stuff is harder than it looks :)
typical.investor
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Re: Muni bonds and taxes

Post by typical.investor »

drbenjamin wrote: Wed Jun 22, 2022 12:51 am My question relates to a (distant?) future when interest rates start to fall. As I understand it, the price of issued bonds (like those held in bond funds) will go up until their overall yield matches that of newly issued bonds. While the overall yield is the same, doesn't the price increase represent a capital gain?
Yes, if you sell. And yes if the fund sells to say maintain a particular duration or has large outflows and has to.
drbenjamin wrote: Wed Jun 22, 2022 12:51 am What I'm wondering is whether my goal of lower taxes with a muni fund will be undermined in a time of lowering interest rates by sizeable capital gains distributions by the fund. For example, I see that last year VWALX had 25% of its distributions as capital gains. Would this go up if interest rates dropped?

Are there funds that avoid cap gain distributions?
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.

Wow, 25% of its distributions as capital gains. Yikes. Personally I use an ETF and generally don't trade in market distress (except in 3.2020 I did sell some municipal bonds at lower than NAV but used that to rebalance into equities which also were quite distraught at that moment. Waiting till end of day and a higher NAV on the bond funds wouldn't have helped me as stocks were also up end of day. I rebalanced three times then and have confirmed this as there is quite a dislike of bond ETFs for that NAV reason. I hasn't hurt me).
Geologist
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Re: Muni bonds and taxes

Post by Geologist »

One thing is that interest rates are going up now. This will create initially unrealized losses in bonds a fund holds. If it realizes those losses, those can be used to offset capital gains realized in the future should interest rates fall again. This makes simplistic connections of interest rate changes to possible capital gains distributions by municipal bond funds more complex.

In addition, bond price changes are larger for longer term funds so a fund like the High Yield Tax Exempt will have bigger changes than intermediate funds (which I think most people on this site would recommend).

If you want to know more about the history of capital gains distributions of Vanguard municipal bond funds, you need to start by looking at the annual report.
ChinchillaWhiplash
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Re: Muni bonds and taxes

Post by ChinchillaWhiplash »

Could this be a rare instance when an actively managed fund might be better than an index fund? Do good managers typically handle tax drag better than just following an index?
Topic Author
drbenjamin
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Re: Muni bonds and taxes

Post by drbenjamin »

ChinchillaWhiplash wrote: Wed Jun 22, 2022 9:24 am Could this be a rare instance when an actively managed fund might be better than an index fund? Do good managers typically handle tax drag better than just following an index?
If I understand correctly, all bond funds are actively managed in the sense that the fund managers have to select a very small subset of the total bonds out there. I did look briefly into SMA - a separately managed account where a broker (Fidelity in my case) sets up and runs a portfolio of individual bonds that you own, but the fees seemed exorbitant.
Topic Author
drbenjamin
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Re: Muni bonds and taxes

Post by drbenjamin »

typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
grok87
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Re: Muni bonds and taxes

Post by grok87 »

drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
you know the thing is, that actually cuts both ways. if one holds on to the mutual fund then one is hurt by others getting out at stale and abnormally high prices.
RIP Mr. Bogle.
typical.investor
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Re: Muni bonds and taxes

Post by typical.investor »

grok87 wrote: Wed Jun 22, 2022 8:38 pm
drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
you know the thing is, that actually cuts both ways. if one holds on to the mutual fund then one is hurt by others getting out at stale and abnormally high prices.
Would it be in anyway economically significant though?

Most people aren't liquidating their entire fixed income holdings in the middle of market distress, and the abnormal pricing return to the market once liquidity resumes.

So wouldn't the effect be unlimited only to that slice that was sold during the liquidity freeze.

And just curious, how do mutual funds transact? Are they giving investors NAV but selling into the market at less than NAV? Are they funding the difference from cash reserves? Wouldn't they soon change their NAV estimates if they are having to sell at a lower price?
Mardoc01
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Re: Muni bonds and taxes

Post by Mardoc01 »

drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
What about vwitx???
Mardoc01
Posts: 153
Joined: Thu Aug 03, 2017 10:31 pm

Re: Muni bonds and taxes

Post by Mardoc01 »

drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
What about vwitx???
Topic Author
drbenjamin
Posts: 6
Joined: Thu Sep 13, 2012 10:56 pm

Re: Muni bonds and taxes

Post by drbenjamin »

Mardoc01 wrote: Wed Jun 22, 2022 10:17 pm
drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
What about vwitx???
VWIUX is the Admiral version of VWITX. It did have a lower capital gains distribution this year, which is a plus for me.
Mardoc01
Posts: 153
Joined: Thu Aug 03, 2017 10:31 pm

Re: Muni bonds and taxes

Post by Mardoc01 »

drbenjamin wrote: Wed Jun 22, 2022 10:33 pm
Mardoc01 wrote: Wed Jun 22, 2022 10:17 pm
drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
What about vwitx???
VWIUX is the Admiral version of VWITX. It did have a lower capital gains distribution this year, which is a plus for me.
Is there an etf equivalent ?
grok87
Posts: 9988
Joined: Tue Feb 27, 2007 9:00 pm

Re: Muni bonds and taxes

Post by grok87 »

typical.investor wrote: Wed Jun 22, 2022 9:25 pm
grok87 wrote: Wed Jun 22, 2022 8:38 pm
drbenjamin wrote: Wed Jun 22, 2022 10:37 am
typical.investor wrote: Wed Jun 22, 2022 1:30 am
ETFs in general have a mechanism to avoid capital gains although sometimes with bond funds do issue them.

Some find ETFs a nuisance to trade, but perhaps the biggest fear of bond ETFs is that in times of distress, the ETF may be trading at a lower price than the NAV which you could get when selling a mutual fund. This is as ETFs are more quickly priced to market conditions while mutual funds may be price on the slightly stale expected values of their holdings.
Thanks, I agree on the ETFs and am leaning towards Vanguard funds (VWALX and VWIUX).
you know the thing is, that actually cuts both ways. if one holds on to the mutual fund then one is hurt by others getting out at stale and abnormally high prices.
Would it be in anyway economically significant though?
i'm not sure. but in general mutual funds with daily liquidity are not a great match for illiquid assets such as municipal bonds. Looking at an extreme case- direct real estate- the TIAA real estate fund charges a liquidity guarantee fee for TIAA providing liquidity as needed
RIP Mr. Bogle.
loghound
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Re: Muni bonds and taxes

Post by loghound »

You could create a bond ladder and only sell them as they mature at part value -- that generally avoids capital gains.

Buying individual bonds is difficult and as a retail investor you don't get really good pricing -- you can get a managed account at places like pimco that will get you (in theory) a better price on the bonds as well as good research but you pay a fee (I think it's around 0.35%)
I would have written a shorter letter, but I did not have the time. | - Blaise Pascal
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