Question about bonds in a taxable account

[DSM]

I have so far putting money in a target date fund (both taxable and tax deferred). This year, I am going to try picking individual index funds for the taxable account.

My plan for 60K/year taxable account saving:

Stocks/Bond: 80/20

Stocks:

Vanguard Tax- Managed capital appreciation fund VMCAX- 50%

Vanguard tax managed small cap admiral(VTMSX)-10%

Vanguard total international stock- 20%

&

Bond: 20%

My tax rate: 25-28% (hoping to get down to 25% this year with more tax deferred saving)

Please advise about appropriate bonds (TIPS/Government/ Corporate/Junk etc.)

[DMFA]

Municipal. You don't want a non-muni bond in taxable because it grows with dividends, which are taxed, and income from municipal bonds is tax-free. VTEAX, VWITX, or equivalent, or state-specific if you live in a state with income tax. You can still get a very small tax drag from fund turnover if there's a capital gain.

[Faithful Steward]

Unless you're the first physician that I've met who falls into the 15% marginal Federal tax bracket, you should look to utilize municipal or tax-free bonds in your taxable account. That is, if you are unwilling to view your entire portfolio holistically.

A better alternative might be to move all of your fixed income holdings into tax-preferred accounts (401(k)s, IRAs, Roth IRAs, etc.) and hold tax-efficient equities in your taxable account.

After all, asset location and tax-efficiency are just as important as asset allocation.

[Faithful Steward]

Be aware that the wash sale rule applies to more than just the taxable account where you plan to harvest the loss.

Back in 2008, the IRS issued Revenue Ruling 2008-5. In it they addressed the question of whether the wash-sale rules apply to IRAs. The IRS explained that when shares are sold in a non-retirement account and substantially identical shares are purchased in an IRA within 30 days, the investor cannot claim tax losses for the sale, and the basis in the individual's IRA is not increased.

[The White Coat Investor]

Sounds like you haven't decided whether to put your bonds in taxable or tax-protected. That's fine, as at our current low interest rates it is unlikely to matter much and it requires a crystal ball to know which is the right decision for you. But as a high earner, the bonds you hold in taxable should generally be muni bond funds and I Bonds. If you want to hold other types of bonds (TIPS, corporates etc) hold them in a tax-protected account.

[StarTrekDoc]

No brainer if in NY/CA  -- municipal bonds in taxable account for that part of the portfolio if maintain taxable.

As Faith mentioned, watch for wash sales with the move -- can use like index funds or ETFs to get around your moves and future tax harvesting events if warranted.

[DSM]

I don't have any in-state muni. I tried to calculate the tax-yield of different bonds. In my calculation, even after paying tax, corporate bonds either VICSx or high yield (>3-4%) would be better in a taxable account compared to muni or Treasury bonds. I understand that the risk is slightly higher in corporate bonds.

Am I missing something?

 

[pistolpete]

I'm looking at Schwab's California Tax-Free Bond Fund (SWCAX), since I'm in California and thinking about putting 10% of my holdings into bonds, which I'd put in my taxable account. It has a net expense ratio of 0.49%. Is this average for a municipal bond? It's so much higher than ETF's!!

 

 

[rb6p]

StarTrekDoc wrote:

No brainer if in NY/CA  — municipal bonds in taxable account for that part of the portfolio if maintain taxable.

As Faith mentioned, watch for wash sales with the move — can use like index funds or ETFs to get around your moves and future tax harvesting events if warranted.

Click to expand...

Hey StarTrekDoc -

I'm relatively new to this, and I'm curious what makes this a no brainer for NY/CA residents.  FYI - I'm in NY and do have most of my taxable account bonds in VNYUX.  I also have some in VWIUX  - I suppose for diversification.

[StarTrekDoc]

California and New York have relatively high state income taxes and garner an advantage in the taxable accounts in using these vehicles to avoid taxation on earnings.  Munis tend to have a lower interest rate, but they are quite stable and with its tax advantage plan a good haven for balanced growth while doubling as a buffer and accessible liquid funds in the taxable account.   Compare that to taxable earnings/distributions:   VBTLX  the tax-exempt outperforms considerably.

We have it as a buffer in lieu of paying down our mortgage.  Earnings beat the mortgage rate straight up before our tax deductions off the mortgage interest, and it allows easy liquidity without tying it directly to a fixed asset in fire prone/earthquake prone california.

[The White Coat Investor]

Crixus wrote:

I Bonds are horrible. Only the first few years when the fixed rate component was around 3% were these any good. With rates at zero, well just look at the following.

Fixed rates

The fixed rate set each May and November applies to all bonds we issue in the six months following the date when we set the rate. The fixed rate applies for the life of the bond.

Date the fixed rate was set	Fixed rate for bonds issued in the six months after that date
May 1, 2017	0.00%
November 1, 2016	0.00%
May 1, 2016	0.10%
November 1, 2015	0.10%
May 1, 2015	0.00%
November 1, 2014	0.00%
May 1, 2014	0.10%
November 1, 2013	0.20%
May 1, 2013	0.00%
November 1, 2012	0.00%
May 1, 2012	0.00%
November 1, 2011	0.00%
May 1, 2011	0.00%
November 1, 2010	0.00%
May 1, 2010	0.20%
November 1, 2009	0.30%
May 1, 2009	0.10%
November 1, 2008	0.70%
May 1, 2008	0.00%
November 1, 2007	1.20%
May 1, 2007	1.30%
November 1, 2006	1.40%
May 1, 2006	1.40%
November 1, 2005	1.00%
May 1, 2005	1.20%
November 1, 2004	1.00%
May 1, 2004	1.00%
November 1, 2003	1.10%
May 1, 2003	1.10%
November 1, 2002	1.60%
May 1, 2002	2.00%
November 1, 2001	2.00%
May 1, 2001	3.00%
November 1, 2000	3.40%
May 1, 2000	3.60%
November 1, 1999	3.40%
May 1, 1999	3.30%
November 1, 1998	3.30%
September 1, 1998	3.40%

Click to expand...

Yes, interest rates are very low and have been for years. But I Bonds are not unique in that aspect. 0% real is about what nominal treasuries and TIPS are paying too. Savings accounts and most CDs are paying even less. But the question wasn't "should I invest in bonds" or "what are current bond yields" it was "which bonds should I invest in in a taxable account." The answer to that question is I Bonds and munis.

[DSM]

@ The white coat Investor: Can you explain why I bonds and munis are better than corporate bonds in the taxable account if the rate is significantly higher in the latter after tax-yield calculation? I can understand that the risk would be higher with the corporate bonds.

[DMFA]

DSM wrote:

I don’t have any in-state muni. I tried to calculate the tax-yield of different bonds. In my calculation, even after paying tax, corporate bonds either VICSx or high yield (>3-4%) would be better in a taxable account compared to muni or Treasury bonds. I understand that the risk is slightly higher in corporate bonds.

Am I missing something?

 

Click to expand...

Tax-adjusted return for VICSX: 2.36%, 2.35%, 2.78% at 1/3/5 yr

Tax-adjusted return for VWIUX: 1.37%, 3.03%, 3.00% at 1/3/5 yr

...so yes, you're missing something.

[The White Coat Investor]

DSM wrote:

@ The white coat Investor: Can you explain why I bonds and munis are better than corporate bonds in the taxable account if the rate is significantly higher in the latter after tax-yield calculation? I can understand that the risk would be higher with the corporate bonds.

Click to expand...

It's not all about rate. It's also about risk. Corporate pay more than savings bonds and muni bonds because they're riskier. Once you have bonds of comparable risk, then you can do the tax calculation to figure out whether to hold a tax-free bond or a taxable bond as your taxable account holding.

But, like Crixus mentions, it's pretty hard to get very excited about any of that at current yields. I bonds at 0% real. Vanguard's TIPS fund is at 0.05% real. Intermediate term corporates- 3.11%. Intermediate munis- 1.69%. Intermediate treasuries- 1.61%. Vanguard Prime MMF had a 5% yield just prior to the 2008 crash. Now 5% seems like a mirage and you wonder if you'll ever make 5% again on a safe fixed income option.

[AZdoc68]

DSM wrote:

@ The white coat Investor: Can you explain why I bonds and munis are better than corporate bonds in the taxable account if the rate is significantly higher in the latter after tax-yield calculation? I can understand that the risk would be higher with the corporate bonds.

Click to expand...

They aren't.  You touched on the considerations---assuming you're fine with the relative risk comparison then all it comes down to is the after-tax return.

Hey, none of us likes paying taxes, I understand that.  But sometimes people get so obsessed with avoiding/minimizing tax liability on their investments that they lose sight of the fact the primary goal is to grow your overall portfolio as best you can within your desired risk profile.  It's not necessarily to avoid paying tax.