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Taxable account bond funds - to muni or not

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  • Taxable account bond funds - to muni or not

    A search of the site shows an article in 2012 saying Muni bonds might not belong in your portfolio, with criticism largely due to state income tax and lack of diversification. Some threads on the forum regarding the funds dropping in value during the recent crash.

    If I am in a state without state income tax, and can take advantage of the Vanguard Tax Exempt Funds, ie VWAHX or VWITX in my taxable account, is there a reason not to? Are the municipal bond funds in some way more inherently risky or otherwise unfavorable, even as a fund and not locked to a single state?

    Of course I will compare the yield of muni vs yield of regular fund like VBTLX after marginal tax rate. However, the actual behavior of this asset seems a bit unpredictable at the moment, so it is not clear how to make accurate long term predictions about expected return rates and recent decrease in principal that has been seen. If someone can advise on this that would be helpful as well.

  • #2
    The big picture shows that all bonds are yielding a pittance, so you have nothing to anguish over.
    No state taxes? great. focus on the after-federal-tax yield.
    Are munis more risky? compared to what? True, munis dont' hold up compared to treasuries during a crisis, but bounce back fast as the crisis resolves.
    My prediction says that long duration bonds are at greatest risk of devaluation now.
    You mentioned VWAHX-- junk bonds yielding 1.80%. that yield is so low-is it worth devaluation during the next panic?

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    • #3
      The way things are going you might be better off keeping your non equity money in a MM account. Right now I dont think I would put anything in a bond fund with a duration over 5 years.

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      • #4
        Is avoiding bonds right now different than timing the market?

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        • #5
          A few quick reactions:
          1. The main reason for bonds in tax deferred is to allow the dividends to reinvest tax deferred. If you are planning to use a tax exempt fund then fine to put in taxable.
          2. Key question as I see it is why you want the bonds. Income? Yields are pretty low right now regardless. I suspect most hold the bond funds as a counterweight to stocks. Dry powder to invest when the stock market drops.
          3. Sure, munis have some additional risk over treasuries. Junk corporate can be riskier still. Will definitely take a hit during a stock crash. So, if answer to question 2 is income and you can ride out the swings, go ahead and buy tax exempt high yield junk bonds. But if you want to dampen volatility, I’d recommend higher quality (hence lower yield) bonds and hold them in tax deferred.

          As for avoiding being equivalent to timing, yes strictly speaking. But if you are just now setting up a new asset allocation, there is no timing police to say you have to buy right now while yields are near all time lows. That said, for my part I would decide my preferred asset allocation and just buy. No sense dragging it out. Be sure to automate future purchases.

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          • #6
            If you are in a higher tax bracket (24+) a National muni fund would probably be worthwhile. Just calculate your tax equivalent yield. Having no state tax is a bonus. As far as safety, consider them between investment grade corporate and treasuries. Investment grade munis rarely default.

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            • #7
              I’ve been invested in VWITX since 2016. I just checked my numbers and my annual return in that fund over the last 4+ years is 4.0%, including appreciation and dividends. I am in the 35% marginal tax bracket for federal. For me it’s been worth it.

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              • #8
                Originally posted by Larry Ragman View Post
                A few quick reactions:
                2. Key question as I see it is why you want the bonds. Income? Yields are pretty low right now regardless. I suspect most hold the bond funds as a counterweight to stocks. Dry powder to invest when the stock market drops.
                Bonds are just part of the asset allocation I setup when doing an IPS a few years back. I set portfolio to have 10% bonds after reading https://www.whitecoatinvestor.com/in-defense-of-bonds/, as another asset class for diversification. Early in investing career, but the diversification over 100% stocks/reits seemed worth it. Hasn't panned out on the short time frame, hah.

                As I am continuously underweighted in bonds per my AA recently, and starting a taxable account, that is the reason for interest in munis. Also having read several posts like this https://www.whitecoatinvestor.com/as...go-in-taxable/

                As I am thinking about this more, what doesn't make a ton of sense to me is the actual value of my bond fund (in tax protected accounts) has been declining, while the rates are also dropping. That is unfortunate, as I am given to understand bond fund prices are expected to typically drop when interest rates go up, which seems the inevitable course when considered over a 30+ year horizon. So having the funds devalued in both directions is too bad, and I do not really understand why that is occurring.

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                • #9
                  @CFE, I like your plan to include 10% bonds. It may be useful to you to clarify the role of bonds within your asset allocation. Typical roles include:
                  --psychological balm during painful stock drawdowns,
                  --dry powder for the stock drawdowns,
                  --current income ( like for retirees )

                  There will always be a dead-dud portion of our portfolios. Bonds are that dud right now.

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                  • #10
                    Originally posted by jz- View Post
                    @CFE, I like your plan to include 10% bonds. It may be useful to you to clarify the role of bonds within your asset allocation.
                    Currently I see them as a way to diversify the portfolio, even if to a small degree. It is my understanding portfolios that approach the efficient frontier are more diversified. Mechanistically I suppose this takes the form of the dry powder option through rebalancing. Or currently preferentially buying the other assets, though I am fast approaching the point in my portfolio where my monthly contributions can't keep up with the market changes in keeping my asset allocation in balance.

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                    • #11
                      Originally posted by ShredtheGnar View Post
                      If you are in a higher tax bracket (24+) a National muni fund would probably be worthwhile. Just calculate your tax equivalent yield. Having no state tax is a bonus. As far as safety, consider them between investment grade corporate and treasuries. Investment grade munis rarely default.
                      THIS ^^^ I also wouldn't invest in any muni bonds above 5 year maturity right now. It's not timing the market, I don't think rates in the US will go negative and they're basically at zero right now.

                      However, for many states (my current state of residence included) expense ratios on muni bond mutual funds and ETFs are prohibitively expensive, and as many here I like to be in control about my finances to a very granular point. So I buy & hold individual muni bonds for my states, wtih sprinkling of US territories (not Puerto Rico, thank you) for dual state+federal tax exemption bonus. For new issues, you can buy at around 5K intervals at no cost thru fidelity.

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