Author Topic: VTEAX (Tax-exempt bond index fund) vs VWIUX (Intermediate-term tax exempt fund)  (Read 554 times)

CrankAddict

  • 5 O'Clock Shadow
  • *
  • Posts: 65
  • Age: 46
My 401k is maxed out and I have an extra $6k/month I'd like to invest.  I'm in the 24% tax bracket with 9-10 years until retirement.  I only recently started adding to a taxable account as well.  Currently it is 50% VTSAX and 50% VMFXX (federal money market).  I'd like to do a little better than the money market for returns, but without putting all my eggs in the stocks basket.  I also want to keep some part of this money fairly liquid in case I want to make a large purchase (second house or rv).  I always read to avoid bonds in a taxable account, but I have been looking at tax exempt funds and they appear to be an "obvious" upgrade from the money market.  Is there any reason to not buy into one of these two?  And if not, any way to choose between the two?  And any covid-specific concerns about muni bonds in general?  From what I've read elsewhere, even during the Great Depression the national default rate on muni bonds wasn't high (15% iirc) but this is an area of great ignorance for me.

https://investor.vanguard.com/mutual-funds/profile/performance/vteax
https://investor.vanguard.com/mutual-funds/profile/performance/vwiux

MustacheAndaHalf

  • Magnum Stache
  • ******
  • Posts: 3674
Either one should be fine.  I'd slightly favor intermediate tax-exempt bond fund (duration 4.7 years) over the tax-exempt bond fund (duration 5.3 years).  If bond yields go up +1%, these funds will lose an amount equal to their duration (-4.7% and -5.3%).  But both funds are fairly close, so either works.

Keep in mind "tax exempt" is only for Federal taxes - not State tax.  If you want a fund that's exempt from taxes in your State, you need a fund that only holds municipal bonds from your state.  Vanguard has several of those, like for CA or NY.

I previously owned tax-exempt bonds (I prefer ETFs, like VTEB).  Those funds hold municipal bonds.  Right now I don't own any, so I can ignore risks like a state or municipality going bankrupt.

CrankAddict

  • 5 O'Clock Shadow
  • *
  • Posts: 65
  • Age: 46
Thanks for the reply.  I did consider the state tax issue but Vanguard doesn't have a Missouri muni fund and given the current climate I figured being spread over many states is probably a better idea since it's unlikely they'll all fail.  I'll have to dig in more to understand the concept you mentioned about the relation to bond yields going up and these funds dropping proportional to duration.  If you have any suggested links on that it would be great.  Otherwise, I've ordered the Thau's Bond Book to try to get a little better understanding of this space.

MustacheAndaHalf

  • Magnum Stache
  • ******
  • Posts: 3674
I've read that book - it will explain in more detail.  But I can provide the basic idea here.

Let's say at the start of 2020 you bought a 10-year treasury yielding 1.88%.  Back in March, the Fed lowered their fund's rate, and bond yields dropped.  Someone buying a 10-year treasury right now would only get 0.59% yield.

Would you swap someone your 1.88% yield for their 0.59% yield?  No way, right?  Because your bond is better, so the market needs to pay you a premium - a higher price for the greater yield.  So the bond you bought in January went up in value because all the new bonds now have lower yields.

Notice when rates fell in that example, your bond yield looked better, and so your bond went up in value.  A more realistic example might be the opposite situation, since bond yields are at historic lows right now.