vanguard muni bond fund advice

[Stache In Training]

Hello All,
Looking for some advice on vanguard bond funds.  I am currently heavy on stocks, and just want a bit more bonds in my AA.  I like muni bonds, because of the dividends being tax free. (well just federal tax free, but I luckily live in wyoming, so no state tax!)  I know the muni bond market just went through a big drop, so while I'm not trying to time the market, it's at least a better time to buy than a year ago.

So looking for advice on which vanguard muni bond fund to do some more research on.  I prefer a higher yield.  I like the high yield fund (VWAHX), but I always thought it was a bit better to have short term muni bonds?  What are the reasons to choose a long-term (as most of vanguard's mni's seem to be) as opposed to a shorter term?

Thanks, in advance!

[Siamond]

Right now (at least in the US), long term bonds seem to be a big NO NO. As interest rates will almost certainly go higher, this is just a really bad time to buy long-term bonds at a low yield (i.e. future return). Even aside from the current bond-unfriendly environment, financial buffs tend to recommend to always go with shorter-term bonds.

Personally, I use VMLTX, this is limited term and low expense ratio. Sure enough, the average return isn't that exciting, but heck, this is the rule of the game with municipal bonds, and yes, this is tax exempt.

[alanwbaker]

I am currently heavy on stocks, and just want a bit more bonds in my AA.  I like muni bonds, because of the dividends being tax free. (well just federal tax free, but I luckily live in wyoming, so no state tax!)  I know the muni bond market just went through a big drop, so while I'm not trying to time the market, it's at least a better time to buy than a year ago.

Before picking muni bond funds, be sure that munis are the best kind of bonds for you.  Muni bonds' interest is tax-free, but their interest rates are significantly lower than corporate bonds.  So if you are in a 40% tax bracket, muni bonds are worthwhile.  If you're in a 15% tax bracket, not so much.

[footenote]

Along with other factors Siamond correctly noted, Detroit is an object lesson not in how risky this sector is right now.

I am invested in two senior subordinated corporate bond funds this past year. They are earning 6% on the short term notes and 7% on longer term notes. Keep researching - you'l find the right investment for you.

[Stache In Training]

Before picking muni bond funds, be sure that munis are the best kind of bonds for you.  Muni bonds' interest is tax-free, but their interest rates are significantly lower than corporate bonds.  So if you are in a 40% tax bracket, muni bonds are worthwhile.  If you're in a 15% tax bracket, not so much.

I am currently in the 25% bracket, but just got a new job, that may (it's commission based) boost me up to the next one.

Since I plan on just letting this sit for the next 10 years, and DRIP, is why I was looking at muni's rather than corporate bonds, so that I'm not being taxed on all of the monthly dividends, that I won't be "seeing."  But I guess if corporate bonds grow that much faster than muni's then it makes up for the amount I'm being taxed?

Also, anytime I hear the explanation as to why to not choose longer term and choose shorter term, it makes sense.  But then why are most of vanguards funds long term, if most people should go with shorter term?  I do have shorter term, and corporate, bonds in my tax-sheltered accounts, which is why I was kind of diversifying more with muni's in my taxable.  Or is that silly?

[Siamond]

Stache, there is nothing silly in your questions & thoughts.

Why are there so many long-term bond funds? I have no idea. Doesn't make a lot of sense to me either. Heck, there is no shortage of weird investment vehicles that make no sense whatsoever, you know. Just a bunch of traps for innocent investing flies...

Adding tax-free muni bonds in your taxable portfolio while a) you are getting in a fairly high tax bracket b) you already filled the tax sheltered part of your portfolio => this is a classic move that many investors in your situation do.

Now as to the high-yield bonds, remember their old nickname? Junk bonds? Ok, this was maybe a tad exaggerated, but fact is those are corporate bonds, and their higher (*average*) return is associated with higher risk. Big companies do go bankrupt (Lehman-Brothers, Nortel or Enron, just to mention a couple). A fairly common view among common sense investors (e.g. the Bogleheads crowd) is that if you want risk, buy equities. But for the more stable & less risky part of your portfolio, you should play it safe, hence avoid corporate (high yield) bonds.

Whether you buy into this view of risk or not, high-yield bonds on a (high bracket) taxable account do not seem to be a very good match. Dividends and taxes will negate all benefits, and all that will be left is risk... Better use munis, then...

Good luck!

[Stache In Training]

Ok, so at least I'm not the only one that thinks the abundance of long-term bonds is funny. (suspicious...ironic... not sure what the right word to use is.)

So high yield bonds aren't worth it if in a higher tax bracket, and can be a bit more riskier.  That's another thing I was liking about muni's, because it's illegal for municipalities to go bankrupt.

So I think that since I have some shorter term, and even some corporate bonds (all in index funds) in my retirement (tax sheltered) accounts, and I am not in low tax brackets, I think I'm going to stick with the muni's.  As I am young (27), I think I can deal with just a slightly higher risk in my bond taxable funds, so I think I'm going to push for the higher muni yields, even though they are longer term.

Anyone seeing anything wrong with that, taking into account the info above?

[alanwbaker]

Stache, what's your current asset allocation (% bonds vs. % stocks)?  What's your target asset allocation?  Are the bonds in your tax-advantaged accounts?

[Stache In Training]

Current: 95.90% in stock, 3.80% in bonds, and .30% in short term reserves (too small to do anything with right now, but have plans to use eventually: in Money Market account.)
Target: 90% stock, 10% bond.

Currently all bonds are in retirement (tax advantaged) accounts.

I want some bonds in my taxable, as I'll want some monthly payments (without necessarily needing to access principal) once in FIRE, as currently the stock index funds for my taxable accounts are quarterly payments.  In other words, I'm hoping to keep my expenses low enough once financially independent, that I can live off of dividend checks, instead of having to sell principal, unless absolutely needed. (tax free muni's will help)  That's the plan, anyway.

[jrhampt]

Well, just be aware that vanguard's definition of "long-term" as regards their muni bond fund isn't actually all that long-term.  I think it's 5-7 years, which isn't too unreasonable.

[Stache In Training]

Well, just be aware that vanguard's definition of "long-term" as regards their muni bond fund isn't actually all that long-term.  I think it's 5-7 years, which isn't too unreasonable.

Ah, very true.  The long-term high yield only holds about 19% where the bonds are over 10 years.  The majority are 5-10; 10% is under 1 year. The average duration is 7.3 years.  So still long, but not as bad when compared to some others.  I know I used to have a muni fund from Oppenheimer, that was listed as limited-term (second shortest term offered), and the average duration was 5.6 years.  So since Vanguard's longest is only 2 year's longer than other's second shortest, you make a very good point.

[kyleaaa]

Vanguard's "long-term" muni bond funds are really intermediate-term muni bond funds by most other fund companies' definition.

[jrhampt]

Vanguard's "long-term" muni bond funds are really intermediate-term muni bond funds by most other fund companies' definition.

I think that's probably a good way of putting it.  For what it's worth, I've been contributing automatically to the "long-term" muni bond fund for the last few years, and I have no intention of stopping.  The fund has lost a bit of value over the last year, but I'm getting higher monthly interest now.  It probably works out in the end if you continue to hold it.

[alanwbaker]

Stache, there's a reason that investors are selling muni bonds in today's low-interest-rate environment.  http://www.reuters.com/article/2013/10/17/lipper-muni-funds-idUSL3N0I74L620131017

A muni bond's interest rate is discounted compared to corporate bonds because it is tax-free.  This discount is maybe 2.5% compared with corporate bonds. In a high-interest-rate environment an investor in a high tax bracket can gain more in tax saving than he loses in interest rate discount.

On the other hand, today's interest rates are so low that those tax savings are insignificant for investors in all but the highest tax brackets.  For someone in the 25 - 28% tax bracket these tax savings are maybe .5%, so you would be giving up 2% in effective earnings with munis.

Although the idea of tax-free income is appealing, it's important to do the math.  For investors seeking safety, the math favors CD's.  For investors seeking income, the math favors corporate bonds.  See also http://www.forbes.com/sites/marcprosser/2013/04/20/are-municipal-bonds-currently-a-good-investment/