best tax exempt bond fund

[Dr Oli]

I'm in the camp of investing in tax exempt bond funds in a taxable account as I'm fortunate enough to be in the top bracket currently, and I don't see the need to risk this money along the way to retirement in an equity fund, especially since I'm fully in equities in retirement accounts and I'm not sure when and if I'll want to use the taxable account money for a multitude of purposes (such as pay mortgage off early, etc).

In this vain I've been in VWIUX (Vanguard intermediate term tax exempt admiral) for months now, which Dan Weiner has a "buy" rating on currently. But recently I've thought that VWALX (Vanguard high yield tax exempt admiral) may be a better way to go. It shows a current yield significantly higher than the intermediate fund (2.26 vs 1.34). Weiner has a "hold" on this high yield fund.

Can anybody tell me why it's not smarter to go with the higher yielding fun, if I don't plan on using any principal in the next five years at least. I understand the price may fluctuate more, but my understanding is that for a bond fund the price mostly reverts back to the mean and it's really the tax free dividends that make up most of what you earn. Am I missing something?

 

[Zaphod]

Those yields are pretty bad, are you in a state that has a tax exempt muni bond fund? I'd look into those, even in california for an unlevered muni fund you can find mid to high 2%.

Recalling you are in Texas, you can go for the national muni bond funds, and if comfortable can look into some closed end funds that may offer better yields, just watch for levels of leverage, effective duration, and quality.

[Hatton]

The reason that you don't want the high yield fund is that it will act like a stock with the next market upheaval.  Junk bonds are riskier and that is why they have a higher yield.  I do not know your age or asset allocation but most people start acquiring bonds to reduce the volitility of their portfolio.  If that is your reason VWIUX is a better choice.

[Dr Oli]

I live in a state with no state income tax, so I don't think I get any benefit from choosing a muni fund from my home state. The Vanguard California intermediate term fund is currently yielding only 1.23%. I'm all ears if you know of intermediate term muni funds currently yielding anything above what VWIUX yields. It's 5 year return is showing 4.5% which is not bad, but I'm assuming a good part of that is in the form of price gains and not yield.

 

[Zaphod]

Dr Oli wrote:

I live in a state with no state income tax, so I don’t think I get any benefit from choosing a muni fund from my home state. The Vanguard California intermediate term fund is currently yielding only 1.23%. I’m all ears if you know of intermediate term muni funds currently yielding anything above what VWIUX yields. It’s 5 year return is showing 4.5% which is not bad, but I’m assuming a good part of that is in the form of price gains and not yield.

 

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The distribution yield is actually around 2.5%, what you're quoting is the SEC yield which is calculated differently.

However, I was really thinking about closed end funds. Some of those use leverage which will effect duration and many people may not be comfortable with that, but there are those that exist without it as well, like NUV that has something like 3.68% distributions which is 5.49% tax effective. Lots of things like that exist.

[Dr Oli]

Zaphod is NUV the one you'd recommend? What are you in? Those yields sound more attractive than Vanguard. And what are the downside risks compared to the Vanguard intermediate fund? Thanks

[Zaphod]

Dr Oli wrote:

Zaphod is NUV the one you’d recommend? What are you in? Those yields sound more attractive than Vanguard. And what are the downside risks compared to the Vanguard intermediate fund? Thanks

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I am in California so am in a bunch of Cali specific funds that dont necessarily appeal to you. For that same reason, the NUV fund was just an example of the kinds of national funds available in the area. Since I only own Cali ones, I dont have much familiarity with them so I'd take it only as an example and starting point to look into further and definitely not an endorsement.

The longer term Cali vanguard fund yields closer to 3% itself, but you increase duration risk.

The danger in closed end funds is that you have to learn a couple new specific terms and be more discerning with your investments. Some can be very illiquid and trade thinly, some are highly leveraged (35-40%), etc...so that will magnify their moves as opposed to the unleveraged cefs and the vanguard ones.

I appreciate the yield and they are relatively stable, but if rates were to really move there could be a flight out of them, and this would really effect the highly levered funds the worst (at which time I would scoop them up with both hands).

So, like anything else you should look into it and see if it works for your temperament and risk, etc...etc...

[jz]

Compared to VWIUX,  VWALX  bears more interest rate and solvency risk.

Using 2013 as a backward stress  test ( Detroit and Puerto Rico),  VWALX lost 7% it's value. The current sec ylds are  2.29% vrs. 1.26% .  Durations are 6.3 years for VWALX  and 4.7 years for VWIUX.

If my timeline was 5 years, I'd stick with VWIUX.

My own timeline is 2.5 years, so I'm sticking with VMLUX.