Bonds in taxable

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Topic Author
ultraviolet
Posts: 138
Joined: Tue Feb 21, 2017 9:32 am

Re: Bonds in taxable

Post by ultraviolet »

Triple digit golfer wrote: Sun Jan 19, 2020 6:14 am
ultraviolet wrote: Sat Jan 18, 2020 10:59 pm
aristotelian wrote: Sat Jan 18, 2020 9:59 pm
ultraviolet wrote: Sat Jan 18, 2020 8:55 pm Ok, how about this question. If I'm ok with the added risk (and I am), what's wrong with putting my emergency fund into a NY municipal bond fund? Since 2001 the max drawdown was a little over 7%. So let's say I added 10% more to the EF, would this be an acceptable way to hold the EF in a way that earns a little more than a standard savings account or MM fund but doesn't cost me anything in taxes? In this case would I just ignore the skewed asset allocation created by having 40k in a muni bond fund? I would imagine I would rebalance annually to maintain the desired EF value using VTSAX and any new money would just go straight into VTSAX.
This has already been answered. It seems like you really, really, really want to hold bonds in taxable. You have been given reasons why that is not recommended. If you still want to do it, go ahead and go for it. You do not have to justify yourself to the Boglehead Police.
I've been given reasons why bonds that are considered part of your AA/risk profile shouldn't be held in a taxable account but I'm just trying to figure out what to do with my EF. I don't want to leave it in a fully taxed savings/MM account. So is keeping it in a municipal bond fund ok and should that be considered part of your total asset allocation?
Would you rebalance into/out of your emergency fund? If yes, it is part of your asset allocation. If no, then it is not.

I had my emergency fund in a taxable high yield savings account until my taxable account (the savings plus my taxable account equities) was double my desired emergency fund size. Then I stopped holding the savings emergency fund altogether and invested it all in equities and exchanged an equal amount from equities to bonds in a tax deferred account.

If I have an emergency, I will simply sell taxable equities and exchange an even amount in tax deferred from equities to bonds, effectively selling bonds for the emergency. If I need the money, I'm covered. If I don't, then I'm invested tax efficiently and can leave it as is indefinitely.

If your taxable account is not double your desired emergency fund amount, I would hold the bonds (or savings or whatever you desire) in taxable and not fret over it.

Cliff notes: I practice the method in the wiki on placing cash needs in a tax deferred account. If taxable account is not twice the desired emergency fund size, don't do it and instead use taxable account (bonds, savings, or whatever) for your emergency fund until it is.
This is something that I read about in the wiki but didn’t fully consider.

So let’s say there’s 100k total split between taxable and tax advantaged. The AA is 90/10. 60k stocks in taxable, 30k stocks in 401k and 10k bonds in 401k. Now let’s say I need 5k. I sell 5k in taxable then rebalance in the 401k, right? As a result of the sale you would be left with 85k stocks and 10k bonds and the account would be worth 95k. So wouldn’t I just exchange 500 in bonds for 500 in equities in order to keep my AA the same? Then you’d have 85.5k stocks and 9.5k bonds. You said “exchange and equal amount equities to bonds in tax deferred”. Did you mean the other way around?
Steadfast
Posts: 257
Joined: Wed Nov 06, 2013 2:44 pm

Re: Bonds in taxable

Post by Steadfast »

We hold our entire bond allocation in taxable (also hold much of our equity in taxable).

Vanguard California Intermediate-Term Tax Exempt (VCADX) makes good sense to me. We are fortunate to be in the highest tax brackets. Distributions from this fund are Federal and state tax free. I’ll take it! The tax equivalent yield is favorable usually. Also doubles as a tappable emergency fund. I understand the risks and theoretical inefficiencies and I sleep well at night.
We don't see things as they are, we see things as we are.
Triple digit golfer
Posts: 10433
Joined: Mon May 18, 2009 5:57 pm

Re: Bonds in taxable

Post by Triple digit golfer »

ultraviolet wrote: Sun Jan 19, 2020 9:45 am
Triple digit golfer wrote: Sun Jan 19, 2020 6:14 am
ultraviolet wrote: Sat Jan 18, 2020 10:59 pm
aristotelian wrote: Sat Jan 18, 2020 9:59 pm
ultraviolet wrote: Sat Jan 18, 2020 8:55 pm Ok, how about this question. If I'm ok with the added risk (and I am), what's wrong with putting my emergency fund into a NY municipal bond fund? Since 2001 the max drawdown was a little over 7%. So let's say I added 10% more to the EF, would this be an acceptable way to hold the EF in a way that earns a little more than a standard savings account or MM fund but doesn't cost me anything in taxes? In this case would I just ignore the skewed asset allocation created by having 40k in a muni bond fund? I would imagine I would rebalance annually to maintain the desired EF value using VTSAX and any new money would just go straight into VTSAX.
This has already been answered. It seems like you really, really, really want to hold bonds in taxable. You have been given reasons why that is not recommended. If you still want to do it, go ahead and go for it. You do not have to justify yourself to the Boglehead Police.
I've been given reasons why bonds that are considered part of your AA/risk profile shouldn't be held in a taxable account but I'm just trying to figure out what to do with my EF. I don't want to leave it in a fully taxed savings/MM account. So is keeping it in a municipal bond fund ok and should that be considered part of your total asset allocation?
Would you rebalance into/out of your emergency fund? If yes, it is part of your asset allocation. If no, then it is not.

I had my emergency fund in a taxable high yield savings account until my taxable account (the savings plus my taxable account equities) was double my desired emergency fund size. Then I stopped holding the savings emergency fund altogether and invested it all in equities and exchanged an equal amount from equities to bonds in a tax deferred account.

If I have an emergency, I will simply sell taxable equities and exchange an even amount in tax deferred from equities to bonds, effectively selling bonds for the emergency. If I need the money, I'm covered. If I don't, then I'm invested tax efficiently and can leave it as is indefinitely.

If your taxable account is not double your desired emergency fund amount, I would hold the bonds (or savings or whatever you desire) in taxable and not fret over it.

Cliff notes: I practice the method in the wiki on placing cash needs in a tax deferred account. If taxable account is not twice the desired emergency fund size, don't do it and instead use taxable account (bonds, savings, or whatever) for your emergency fund until it is.
This is something that I read about in the wiki but didn’t fully consider.

So let’s say there’s 100k total split between taxable and tax advantaged. The AA is 90/10. 60k stocks in taxable, 30k stocks in 401k and 10k bonds in 401k. Now let’s say I need 5k. I sell 5k in taxable then rebalance in the 401k, right? As a result of the sale you would be left with 85k stocks and 10k bonds and the account would be worth 95k. So wouldn’t I just exchange 500 in bonds for 500 in equities in order to keep my AA the same? Then you’d have 85.5k stocks and 9.5k bonds. You said “exchange and equal amount equities to bonds in tax deferred”. Did you mean the other way around?
I misspoke. I meant exchange bonds to equities in taxable. Sorry for the confusion.

If you consider your emergency fund separate from your AA, then I would set it up like this at a 90/10 AA and assuming a $10k emergency fund, with $100k total, using your example above:

$60k stocks in taxable
$21k stocks in tax deferred (401k)
$19k bonds in tax deferred (401k) - this would be $10k "emergency fund" and $9k bond allocation

This way, if I take the $10k out for an emergency and assume my AA is only $90k, I'm invested at 90/10 ($81k stocks and $9k bonds).

If I need the cash, sell $10k of stocks in taxable, exchange $10k from bonds to stocks in tax deferred, and I'm left with:

$50k stocks in taxable
$31k stocks in tax deferred (401k)
$9k bonds in tax deferred (401k) - this would be $9k bond allocation; emergency fund is depleted.

My AA is still 90/10, but I've depleted my emergency fund. At this point, I can redirect the next $10k of new money back to bonds.

If I consider my emergency fund as part of my AA, it would look like this:

$60k stocks in taxable
$30k stocks in tax deferred (401k)
$10k bonds in tax deferred (401k)

If I take the $10k out for an emergency and do the exchange in tax deferred, I'm left with:

$50k stocks in taxable
$40k stocks in tax deferred
$0 bonds

Now, I have no more bond cushion. However, this isn't the worst situation because I still have a large taxable account valued at 5x my emergency fund amount. As above, you direct the next $10k back to bonds so that you're back to 90/10.

I went back and forth a lot with the whole idea of an emergency fund. As our portfolio and taxable account grew, I stopped considering an emergency fund at all and chose to simply view our entire portfolio in our AA (except for 1-2 months of expenses in savings for simplicity and covering non-regular bills, and also adding a few hundred a month for items like our next new car). I simply keep this money in our savings, separate from our AA, and everything else is invested according to our AA at 80/20 in the most tax-efficient manner (bonds in tax deferred).

Rule of thumb: the larger your portfolio, and larger your taxable account, the less likely you need a separate (whether actually separate or just mentally separate) emergency fund. In real life, I have a bond allocation equal to about 2.5 years of expenses at this point. Even if I have an emergency that equals six months of expenses (the amount most "experts" recommend), I still have 2 years of bonds left, so I can take my time replenishing if I want. In the mean time, if another emergency arises, I do the same thing and I'm left with 1.5 years. I haven't sold any equities yet because my bond portion acted as my emergency fund.
Topic Author
ultraviolet
Posts: 138
Joined: Tue Feb 21, 2017 9:32 am

Re: Bonds in taxable

Post by ultraviolet »

Triple digit golfer wrote: Sun Jan 19, 2020 11:22 am
ultraviolet wrote: Sun Jan 19, 2020 9:45 am
Triple digit golfer wrote: Sun Jan 19, 2020 6:14 am
ultraviolet wrote: Sat Jan 18, 2020 10:59 pm
aristotelian wrote: Sat Jan 18, 2020 9:59 pm

This has already been answered. It seems like you really, really, really want to hold bonds in taxable. You have been given reasons why that is not recommended. If you still want to do it, go ahead and go for it. You do not have to justify yourself to the Boglehead Police.
I've been given reasons why bonds that are considered part of your AA/risk profile shouldn't be held in a taxable account but I'm just trying to figure out what to do with my EF. I don't want to leave it in a fully taxed savings/MM account. So is keeping it in a municipal bond fund ok and should that be considered part of your total asset allocation?
Would you rebalance into/out of your emergency fund? If yes, it is part of your asset allocation. If no, then it is not.

I had my emergency fund in a taxable high yield savings account until my taxable account (the savings plus my taxable account equities) was double my desired emergency fund size. Then I stopped holding the savings emergency fund altogether and invested it all in equities and exchanged an equal amount from equities to bonds in a tax deferred account.

If I have an emergency, I will simply sell taxable equities and exchange an even amount in tax deferred from equities to bonds, effectively selling bonds for the emergency. If I need the money, I'm covered. If I don't, then I'm invested tax efficiently and can leave it as is indefinitely.

If your taxable account is not double your desired emergency fund amount, I would hold the bonds (or savings or whatever you desire) in taxable and not fret over it.

Cliff notes: I practice the method in the wiki on placing cash needs in a tax deferred account. If taxable account is not twice the desired emergency fund size, don't do it and instead use taxable account (bonds, savings, or whatever) for your emergency fund until it is.
This is something that I read about in the wiki but didn’t fully consider.

So let’s say there’s 100k total split between taxable and tax advantaged. The AA is 90/10. 60k stocks in taxable, 30k stocks in 401k and 10k bonds in 401k. Now let’s say I need 5k. I sell 5k in taxable then rebalance in the 401k, right? As a result of the sale you would be left with 85k stocks and 10k bonds and the account would be worth 95k. So wouldn’t I just exchange 500 in bonds for 500 in equities in order to keep my AA the same? Then you’d have 85.5k stocks and 9.5k bonds. You said “exchange and equal amount equities to bonds in tax deferred”. Did you mean the other way around?
I misspoke. I meant exchange bonds to equities in taxable. Sorry for the confusion.

If you consider your emergency fund separate from your AA, then I would set it up like this at a 90/10 AA and assuming a $10k emergency fund, with $100k total, using your example above:

$60k stocks in taxable
$21k stocks in tax deferred (401k)
$19k bonds in tax deferred (401k) - this would be $10k "emergency fund" and $9k bond allocation

This way, if I take the $10k out for an emergency and assume my AA is only $90k, I'm invested at 90/10 ($81k stocks and $9k bonds).

If I need the cash, sell $10k of stocks in taxable, exchange $10k from bonds to stocks in tax deferred, and I'm left with:

$50k stocks in taxable
$31k stocks in tax deferred (401k)
$9k bonds in tax deferred (401k) - this would be $9k bond allocation; emergency fund is depleted.

My AA is still 90/10, but I've depleted my emergency fund. At this point, I can redirect the next $10k of new money back to bonds.

If I consider my emergency fund as part of my AA, it would look like this:

$60k stocks in taxable
$30k stocks in tax deferred (401k)
$10k bonds in tax deferred (401k)

If I take the $10k out for an emergency and do the exchange in tax deferred, I'm left with:

$50k stocks in taxable
$40k stocks in tax deferred
$0 bonds

Now, I have no more bond cushion. However, this isn't the worst situation because I still have a large taxable account valued at 5x my emergency fund amount. As above, you direct the next $10k back to bonds so that you're back to 90/10.

I went back and forth a lot with the whole idea of an emergency fund. As our portfolio and taxable account grew, I stopped considering an emergency fund at all and chose to simply view our entire portfolio in our AA (except for 1-2 months of expenses in savings for simplicity and covering non-regular bills, and also adding a few hundred a month for items like our next new car). I simply keep this money in our savings, separate from our AA, and everything else is invested according to our AA at 80/20 in the most tax-efficient manner (bonds in tax deferred).

Rule of thumb: the larger your portfolio, and larger your taxable account, the less likely you need a separate (whether actually separate or just mentally separate) emergency fund. In real life, I have a bond allocation equal to about 2.5 years of expenses at this point. Even if I have an emergency that equals six months of expenses (the amount most "experts" recommend), I still have 2 years of bonds left, so I can take my time replenishing if I want. In the mean time, if another emergency arises, I do the same thing and I'm left with 1.5 years. I haven't sold any equities yet because my bond portion acted as my emergency fund.
This concept makes a lot of sense to me. It also satisfies my desire to not have cash just sitting around. It really simplifies things. I was considering my EF as part of my AA and that’s partly why this became an issue for me. My emergency fund just recently hit the level I want it to be and I was trying to figure out what to do with the new savings. Plus I was looking at it and thinking, “is this MM account fixed income? If so it’s like 30% of my portfolio. Do I need bonds?” Now I know the answers to those questions. I think this year I’ll put half the MM into equities and then build up the MM account again. Then repeat that one more time and finally put it all in equities.
Big Dog
Posts: 4608
Joined: Mon Sep 07, 2015 4:12 pm

Re: Bonds in taxable

Post by Big Dog »

ultraviolet wrote: Sat Jan 18, 2020 10:59 pm
aristotelian wrote: Sat Jan 18, 2020 9:59 pm
ultraviolet wrote: Sat Jan 18, 2020 8:55 pm Ok, how about this question. If I'm ok with the added risk (and I am), what's wrong with putting my emergency fund into a NY municipal bond fund? Since 2001 the max drawdown was a little over 7%. So let's say I added 10% more to the EF, would this be an acceptable way to hold the EF in a way that earns a little more than a standard savings account or MM fund but doesn't cost me anything in taxes? In this case would I just ignore the skewed asset allocation created by having 40k in a muni bond fund? I would imagine I would rebalance annually to maintain the desired EF value using VTSAX and any new money would just go straight into VTSAX.
This has already been answered. It seems like you really, really, really want to hold bonds in taxable. You have been given reasons why that is not recommended. If you still want to do it, go ahead and go for it. You do not have to justify yourself to the Boglehead Police.
I've been given reasons why bonds that are considered part of your AA/risk profile shouldn't be held in a taxable account but I'm just trying to figure out what to do with my EF. I don't want to leave it in a fully taxed savings/MM account. So is keeping it in a municipal bond fund ok and should that be considered part of your total asset allocation?
I kept my EF in Vanguard's CA bond fund while working but since just recently retired, I moved the EF to a short-term taxable bond fund. (for a higher yield than MMF.) And yes, I consider it part of my AA, the 'cash' part.
pascalwager
Posts: 2327
Joined: Mon Oct 31, 2011 8:36 pm

Re: Bonds in taxable

Post by pascalwager »

palanzo wrote: Sat Jan 18, 2020 9:41 pm
pascalwager wrote: Sat Jan 18, 2020 9:27 pm I have TIPS funds in both my Rollover IRA and in a taxable account. As a retiree, I decided that inflation protection was more important than tax efficiency.
Can you talk more about which funds you use in which accounts and what the tax impact is of using TIPS? I don't see this discussed very much.
Portfolio:

56% stocks / 44% bonds

Percentages of overall bond holdings:

Variable Annuity: 53% Total Bond Market
Rollover IRA: 28% VG Inflation-Protected Securities
Individual Account (taxable): 19% VG Inflation-Protected Securities

During high inflation, you'd be paying proportionally higher taxes for the TIPS fund. You don't want to hold individual TIPS in taxable because of accounting complexities. I might like to use even more TIPS, but TIPS are not available in the VA.
Last edited by pascalwager on Sun Jan 19, 2020 9:38 pm, edited 1 time in total.
VT 60% / VFSUX 20% / TIPS 20%
palanzo
Posts: 2146
Joined: Thu Oct 10, 2019 4:28 pm

Re: Bonds in taxable

Post by palanzo »

pascalwager wrote: Sun Jan 19, 2020 4:11 pm
palanzo wrote: Sat Jan 18, 2020 9:41 pm
pascalwager wrote: Sat Jan 18, 2020 9:27 pm I have TIPS funds in both my Rollover IRA and in a taxable account. As a retiree, I decided that inflation protection was more important than tax efficiency.
Can you talk more about which funds you use in which accounts and what the tax impact is of using TIPS? I don't see this discussed very much.
Portfolio:

56% stocks / 44% bonds

Percentages of overall bond holdings:

Variable Annuity: 53% Total Bond Market
Rollover IRA: 28% VG Inflation-Protected Securities
Individual Account (taxable): 19% VG Inflation-Protected

During high inflation, you'd be paying proportionally higher taxes for the TIPS fund. You don't want to hold individual TIPS in taxable because of accounting complexities. I might like to use even more TIPS, but TIPS are not available in the VA.
Thanks pascalwager. Are you using VIPSX rather than VTAPX in taxable? I'm trying to understand the implications of using TIPS in taxable rather than say ST or IT Treasuries. I also have TBM in a rollover IRA and was thinking of 50% TBM and 50% TIPS as you have.
pascalwager
Posts: 2327
Joined: Mon Oct 31, 2011 8:36 pm

Re: Bonds in taxable

Post by pascalwager »

palanzo wrote: Sun Jan 19, 2020 6:13 pm
pascalwager wrote: Sun Jan 19, 2020 4:11 pm
palanzo wrote: Sat Jan 18, 2020 9:41 pm
pascalwager wrote: Sat Jan 18, 2020 9:27 pm I have TIPS funds in both my Rollover IRA and in a taxable account. As a retiree, I decided that inflation protection was more important than tax efficiency.
Can you talk more about which funds you use in which accounts and what the tax impact is of using TIPS? I don't see this discussed very much.
Portfolio:

56% stocks / 44% bonds

Percentages of overall bond holdings:

Variable Annuity: 53% Total Bond Market
Rollover IRA: 28% VG Inflation-Protected Securities
Individual Account (taxable): 19% VG Inflation-Protected

During high inflation, you'd be paying proportionally higher taxes for the TIPS fund. You don't want to hold individual TIPS in taxable because of accounting complexities. I might like to use even more TIPS, but TIPS are not available in the VA.
Thanks pascalwager. Are you using VIPSX rather than VTAPX in taxable? I'm trying to understand the implications of using TIPS in taxable rather than say ST or IT Treasuries. I also have TBM in a rollover IRA and was thinking of 50% TBM and 50% TIPS as you have.
I'm using VAIPX, the intermediate-term TIPS fund, to better match my investment horizon compared to the short-term version. Actually, I'd like a few years longer duration, but such is not available at Vanguard.
VT 60% / VFSUX 20% / TIPS 20%
stocknoob4111
Posts: 3509
Joined: Sun Jan 07, 2018 11:52 am

Re: Bonds in taxable

Post by stocknoob4111 »

Steadfast wrote: Sun Jan 19, 2020 9:48 am Vanguard California Intermediate-Term Tax Exempt (VCADX) makes good sense to me. We are fortunate to be in the highest tax brackets. Distributions from this fund are Federal and state tax free.
This may make sense in your tax bracket but one has to be careful here... the SEC yield on this fund is 1.34% vs a 2.16% yield on VBILX. That's a 38% lower yield which you may not really make up with the tax savings.

Personally I don't buy the CA Muni bond funds because they have ridiculously low yields and it's just pointless. In addition, you don't get the diversification of a fund like VBILX and I personally think that is riskier although some don't think it is.
pascalwager
Posts: 2327
Joined: Mon Oct 31, 2011 8:36 pm

Re: Bonds in taxable

Post by pascalwager »

stocknoob4111 wrote: Mon Jan 20, 2020 12:28 am
Steadfast wrote: Sun Jan 19, 2020 9:48 am Vanguard California Intermediate-Term Tax Exempt (VCADX) makes good sense to me. We are fortunate to be in the highest tax brackets. Distributions from this fund are Federal and state tax free.
This may make sense in your tax bracket but one has to be careful here... the SEC yield on this fund is 1.34% vs a 2.16% yield on VBILX. That's a 38% lower yield which you may not really make up with the tax savings.

Personally I don't buy the CA Muni bond funds because they have ridiculously low yields and it's just pointless. In addition, you don't get the diversification of a fund like VBILX and I personally think that is riskier although some don't think it is.
Yes, and especially the CA money market fund.
VT 60% / VFSUX 20% / TIPS 20%
Steadfast
Posts: 257
Joined: Wed Nov 06, 2013 2:44 pm

Re: Bonds in taxable

Post by Steadfast »

stocknoob4111 wrote: Mon Jan 20, 2020 12:28 am
Steadfast wrote: Sun Jan 19, 2020 9:48 am Vanguard California Intermediate-Term Tax Exempt (VCADX) makes good sense to me. We are fortunate to be in the highest tax brackets. Distributions from this fund are Federal and state tax free.
This may make sense in your tax bracket but one has to be careful here... the SEC yield on this fund is 1.34% vs a 2.16% yield on VBILX. That's a 38% lower yield which you may not really make up with the tax savings.
OK, now I'm curious since I don't check closely very often:

My Federal tax bracket is 37% and my CA state bracket is 11.3% so a combined tax rate of 48.3%. In a taxable account, this would chop the after-tax yield on your suggested fund (VBILX @ 2.16) down to 1.11%. So I think that means I get a 20% higher after-tax return using my in-state muni fund (VCADX) even with its paltry 1.34% yield, than with a taxable bond fund appearing to yield a lot more.

It seems VBILX would need to yield more than 4% to be tax effective for me. Even excluding state tax, it would need to yield 3.58%.
We don't see things as they are, we see things as we are.
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Clever_Username
Posts: 1915
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Location: Southern California

Re: Bonds in taxable

Post by Clever_Username »

stocknoob4111 wrote: Mon Jan 20, 2020 12:28 am Personally I don't buy the CA Muni bond funds because they have ridiculously low yields and it's just pointless. In addition, you don't get the diversification of a fund like VBILX and I personally think that is riskier although some don't think it is.
How do you feel about a mix? I use CA Long-term muni bond fund for half of my taxable bond allocation (non-series I portion) and the other half is short-term federal treasuries fund. I get some diversification while having a good sheltering of a lot of the distributions (which I have no choice in).
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.
stocknoob4111
Posts: 3509
Joined: Sun Jan 07, 2018 11:52 am

Re: Bonds in taxable

Post by stocknoob4111 »

Steadfast wrote: Mon Jan 20, 2020 1:38 pm It seems VBILX would need to yield more than 4% to be tax effective for me. Even excluding state tax, it would need to yield 3.58%.
A super rough calculation:

I plugged both VBILX and VCADX in Portfolio Visualizer. From 2010-2019 starting with a $100K principal the ending balance was:

$159,396 for VBILX
$151,820 for VCADX

VBILX is 60% tax deductible at the state level so your effective Annual CA tax is 11.3 * .4 = 4.52% + Fed 37% = Total Tax: 41.52%
For VBILX if you deduct the Annual taxes at (4.47 average income over the decade * .4152 = 1.855%) = Ending balance $132,246

Over a decade VBILX results in $132,246 after taxes withdrawn annually vs VCADX at the tax free $151,820

This does not take into account tax loss harvesting possibilities in Taxable though but at your super high tax bracket VCADX comes out way ahead.

Adjusting for my bracket: 24% Fed, 9.3% CA State yields :

Effective CA Tax: 9.3 * .4 = 3.72% + 24 = Total Tax: 27.72%
4.47 * .372 = 1.66% withdrawn annually from total return = 134, 828

So in both circumstances VCADX comes out ahead in the 10 year period 2010-2019

Part of the reason is that the SEC yield is 1.34% on VCADX but it is currently distributing 2.4% in yields which is only a tad lower than 2.65% with VBILX. I think this calculation is far more complex than simply using SEC yield and deducting the taxes since the SEC yield is using a static analysis of the fund but in real life this is highly dynamic based on which bonds in the fund mature and at what rate the new bonds are acquired throughout the duration.

What I am saying is that VBILX's distribution is much closer to it's SEC yield, VCADX distribution is very far off from it's SEC yield. I suspect VCADX's distributions will fall off a cliff soon whenever the higher yielding bonds drop off. I may be wrong in my assumptions but perhaps someone who understands this better can clarify if this is true.

Perhaps someone can chime in to explain how SEC yield is calculated with regard to maturing bonds, does it assume that if a bond matures that it is replaced with an equivalent bond at the same rate? Or is the bond simply removed from the mix?
palanzo
Posts: 2146
Joined: Thu Oct 10, 2019 4:28 pm

Re: Bonds in taxable

Post by palanzo »

stocknoob4111 wrote: Mon Jan 20, 2020 2:31 pm
Steadfast wrote: Mon Jan 20, 2020 1:38 pm It seems VBILX would need to yield more than 4% to be tax effective for me. Even excluding state tax, it would need to yield 3.58%.
A super rough calculation:

I plugged both VBILX and VCADX in Portfolio Visualizer. From 2010-2019 starting with a $100K principal the ending balance was:

$159,396 for VBILX
$151,820 for VCADX

VBILX is 60% tax deductible at the state level so your effective Annual CA tax is 11.3 * .4 = 4.52% + Fed 37% = Total Tax: 41.52%
For VBILX if you deduct the Annual taxes at (4.47 average income over the decade * .4152 = 1.855%) = Ending balance $132,246

Over a decade VBILX results in $132,246 after taxes withdrawn annually vs VCADX at the tax free $151,820

This does not take into account tax loss harvesting possibilities in Taxable though but at your super high tax bracket VCADX comes out way ahead.

Adjusting for my bracket: 24% Fed, 9.3% CA State yields :

Effective CA Tax: 9.3 * .4 = 3.72% + 24 = Total Tax: 27.72%
4.47 * .372 = 1.66% withdrawn annually from total return = 134, 828

So in both circumstances VCADX comes out ahead in the 10 year period 2010-2019

Part of the reason is that the SEC yield is 1.34% on VCADX but it is currently distributing 2.4% in yields which is only a tad lower than 2.65% with VBILX. I think this calculation is far more complex than simply using SEC yield and deducting the taxes since the SEC yield is using a static analysis of the fund but in real life this is highly dynamic based on which bonds in the fund mature and at what rate the new bonds are acquired throughout the duration.

What I am saying is that VBILX's distribution is much closer to it's SEC yield, VCADX distribution is very far off from it's SEC yield. I suspect VCADX's distributions will fall off a cliff soon whenever the higher yielding bonds drop off. I may be wrong in my assumptions but perhaps someone who understands this better can clarify if this is true.

Perhaps someone can chime in to explain how SEC yield is calculated with regard to maturing bonds, does it assume that if a bond matures that it is replaced with an equivalent bond at the same rate? Or is the bond simply removed from the mix?
I have done similar calculations and would suggest you run a TT simulation. You may find the annual tax due is quite different from your marginal rates due to various aspects of the tax code. In doing so I was quite surprised by the differences in using different funds in taxable.
stocknoob4111
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Re: Bonds in taxable

Post by stocknoob4111 »

palanzo wrote: Mon Jan 20, 2020 2:51 pm I have done similar calculations and would suggest you run a TT simulation. You may find the annual tax due is quite different from your marginal rates due to various aspects of the tax code. In doing so I was quite surprised by the differences in using different funds in taxable.
I ran the numbers in Portfolio Visualizer using the "Withdraw fixed percentage" annually option which removes the taxes (as a percentage of the CAGR) from the ending balance each year. The calculation isn't exact as the CAGR isn't a constant 4.47% but it's the average CAGR through the decade. Doing exact calculations would be too painstaking.

Also, I think it's a bit flawed as the 4.47% assumes all of it is income when the fund has has 10% in capital appreciation since 2010 (NAV 10.88 to 11.84 through end 2019) which is included in the return so in effect the taxes should be lower.
palanzo
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Re: Bonds in taxable

Post by palanzo »

stocknoob4111 wrote: Mon Jan 20, 2020 2:56 pm
palanzo wrote: Mon Jan 20, 2020 2:51 pm I have done similar calculations and would suggest you run a TT simulation. You may find the annual tax due is quite different from your marginal rates due to various aspects of the tax code. In doing so I was quite surprised by the differences in using different funds in taxable.
I ran the numbers in Portfolio Visualizer using the "Withdraw fixed percentage" annually option which removes the taxes (as a percentage of the CAGR) from the ending balance each year. The calculation isn't exact as the CAGR isn't a constant 4.47% but it's the average CAGR through the decade. Doing exact calculations would be too painstaking. Also, I think it's a bit flawed as the 4.47% assumes all of it is income when the fund has has 10% in capital appreciation which is included in the return so in effect the taxes should be lower.
Got it. 4.47% is the CAGR over the decade. With TurboTax I just pick a tax year (2019 for example), calculate the dividends from the bond funds I want to compare and then put the dividends in TT. TT does all the hard work and I can compare the dividends received and the Federal and State taxes incurred.
sman09
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Re: Bonds in taxable

Post by sman09 »

aristotelian wrote: Sat Jan 18, 2020 4:16 pm It has only partially to do with the tax drag on the bond yield, which can be easily solved using mini bonds. The real reason is that by holding stocks in your 401k, you are causing the stock gains to be taxed as ordinary income upon withdrawal. Even though the tax is deferred, income tax is always higher than Long Term Capital Gains tax. Just imagine choosing between $500k taxable/$1M 401k vs $1M taxable/$500k 401k. If you keep the highest return asset in taxable, the second is a more likely outcome.
Interesting observation. Have not thought on those lines before.

Also, what do you mean by "mini bonds"?
aristotelian
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Re: Bonds in taxable

Post by aristotelian »

sman09 wrote: Wed Jun 30, 2021 11:43 pm
aristotelian wrote: Sat Jan 18, 2020 4:16 pm It has only partially to do with the tax drag on the bond yield, which can be easily solved using mini bonds. The real reason is that by holding stocks in your 401k, you are causing the stock gains to be taxed as ordinary income upon withdrawal. Even though the tax is deferred, income tax is always higher than Long Term Capital Gains tax. Just imagine choosing between $500k taxable/$1M 401k vs $1M taxable/$500k 401k. If you keep the highest return asset in taxable, the second is a more likely outcome.
Interesting observation. Have not thought on those lines before.

Also, what do you mean by "mini bonds"?
Oops, I meant muni (tax free municipal) bonds
BlueMoonXD
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Re: Bonds in taxable

Post by BlueMoonXD »

abuss368 wrote: Sun Jan 19, 2020 8:54 am We had tax exempt bonds in taxable during the financial crisis. We had that pool of dry powder available to rebalance back into stocks. In hindsight that worked very well.
Really one of the best argument for bonds in taxable in my opinion.

A big logistical frustration with taxable accounts is the inability to rebalance without generating capital gains. I'm willing to trade some tax efficiency for the benefit of having an asset class that can easily be sold to rebalance. The psychological benefit of having something exciting to do at a time when your overall portfolio is taking a beating is an underrated benefit as well. Much easier to stomach a downturn when I can sell bonds for equities in taxable and feel like I'm getting a steal.
GoneOnTilt
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Re: Bonds in taxable

Post by GoneOnTilt »

BlueMoonXD wrote: Thu Jul 01, 2021 2:18 pm
abuss368 wrote: Sun Jan 19, 2020 8:54 am We had tax exempt bonds in taxable during the financial crisis. We had that pool of dry powder available to rebalance back into stocks. In hindsight that worked very well.
Really one of the best argument for bonds in taxable in my opinion.

A big logistical frustration with taxable accounts is the inability to rebalance without generating capital gains. I'm willing to trade some tax efficiency for the benefit of having an asset class that can easily be sold to rebalance. The psychological benefit of having something exciting to do at a time when your overall portfolio is taking a beating is an underrated benefit as well. Much easier to stomach a downturn when I can sell bonds for equities in taxable and feel like I'm getting a steal.
I'm in the 22% federal tax bracket. I hold bonds in taxable, mainly in the Vanguard LifeStrategy Income Fund. I see no reason why not to. I get a much better yield than cash, will likely not need the money in the next 4-10 years (Vanguard's risk horizon), and am getting some capital growth along the way. I don't see the downside as an alternative to cash for a moderate time horizon -- in my particular situation. I'm willing to take some risk for some reward.
Last edited by GoneOnTilt on Tue Jul 06, 2021 5:32 pm, edited 1 time in total.
Exchme
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Re: Bonds in taxable

Post by Exchme »

For better or worse, I put a few years of expenses in bonds in taxable in the years before retirement. Now I can control my income for a while and that may allow me to get some ACA subsidies before Medicare kicks in. That looks like a bigger nugget than the difference in tax drag. Of course, you have to be close to the ACA limits in the first place for the difference to matter, but it illustrates that you need to look at the whole picture.
hudson
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Re: Bonds in taxable

Post by hudson »

pascalwager wrote: Sun Jan 19, 2020 9:50 pm I'm using VAIPX, the intermediate-term TIPS fund, to better match my investment horizon compared to the short-term version. Actually, I'd like a few years longer duration, but such is not available at Vanguard.
You probably already know about longer TIPS ETFs like
SWRSX...https://www.schwabassetmanagement.com/r ... fact-sheet
and
LTPZ...https://www.pimco.com/en-us/investments ... raded-fund
Johnathon Livingston
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Re: Bonds in taxable

Post by Johnathon Livingston »

I think bonds in a taxable account is fine if it’s part of an emergency fund and you just want to draw some interest to combat inflation. With money market and CDs providing next to nothing in interest, holding some bonds in a taxable account might be a better alternative even after you pay taxes (if you aren’t using tax exempt munis).

Picking the right bond fund is the fun/hard part.

Good luck.
Blue456
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Re: Bonds in taxable

Post by Blue456 »

ultraviolet wrote: Sat Jan 18, 2020 10:28 am I’m sorry to bring this up again but I’m still not understanding why bonds should (with few exceptions) be placed in a tax advantaged account according to standard financial planning advice. I get the yield is taxable but if you choose a fund that has some tax advantages like vanguard inter term bond index VBILX, why wouldn’t it make sense to put it in a taxable account and keep the tax advantaged account all stocks? That way they can attain maximum growth. As a NYC resident my taxable equivalent yield for VBILX is about 2.28%.

I want to use bonds as a tier 2 emergency fund in my taxable account. My initial emergency fund savings contributions went into the prime money market (which is now fully funded). Now I’d like to start adding funds to VBILX and when 10% of my total assets are in VBILX the savings contribution will go into VTSAX. All this time my tax advantaged accounts are fully funded.

Is this a dumb idea?
Don't let the tail wag the dog. Make sure to do your research and be aware how much in taxes you are going to pay 10 years down the road.
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abuss368
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Re: Bonds in taxable

Post by abuss368 »

BlueMoonXD wrote: Thu Jul 01, 2021 2:18 pm
abuss368 wrote: Sun Jan 19, 2020 8:54 am We had tax exempt bonds in taxable during the financial crisis. We had that pool of dry powder available to rebalance back into stocks. In hindsight that worked very well.
Really one of the best argument for bonds in taxable in my opinion.

A big logistical frustration with taxable accounts is the inability to rebalance without generating capital gains. I'm willing to trade some tax efficiency for the benefit of having an asset class that can easily be sold to rebalance. The psychological benefit of having something exciting to do at a time when your overall portfolio is taking a beating is an underrated benefit as well. Much easier to stomach a downturn when I can sell bonds for equities in taxable and feel like I'm getting a steal.
For us there was a psychological aspect as well. While we look at the overall portfolio, we did not want to have one account decline that much during a market pullback. There are many roads to Rome and in my opinion this is dancing on the head of a pin.

Best.
Tony
John C. Bogle: “Simplicity is the master key to financial success."
pascalwager
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Re: Bonds in taxable

Post by pascalwager »

hudson wrote: Fri Jul 02, 2021 1:32 pm
pascalwager wrote: Sun Jan 19, 2020 9:50 pm I'm using VAIPX, the intermediate-term TIPS fund, to better match my investment horizon compared to the short-term version. Actually, I'd like a few years longer duration, but such is not available at Vanguard.
You probably already know about longer TIPS ETFs like
SWRSX...https://www.schwabassetmanagement.com/r ... fact-sheet
and
LTPZ...https://www.pimco.com/en-us/investments ... raded-fund
Yes, I've since been using a combination of SCHP, VAIPX, LTPZ, and S.T.I.G. to better match my investment horizon.
hudson
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Re: Bonds in taxable

Post by hudson »

pascalwager wrote: Thu Jul 08, 2021 10:50 pm
hudson wrote: Fri Jul 02, 2021 1:32 pm
pascalwager wrote: Sun Jan 19, 2020 9:50 pm I'm using VAIPX, the intermediate-term TIPS fund, to better match my investment horizon compared to the short-term version. Actually, I'd like a few years longer duration, but such is not available at Vanguard.
You probably already know about longer TIPS ETFs like
SWRSX...https://www.schwabassetmanagement.com/r ... fact-sheet
and
LTPZ...https://www.pimco.com/en-us/investments ... raded-fund
Yes, I've since been using a combination of SCHP, VAIPX, LTPZ, and S.T.I.G. to better match my investment horizon.
(I see that this is a resurrected discussion from Jan. 2020.)
The first 3 in your list are on my list for a future project in Jan. 2024. I will be 76 and am planning to create a liability matching portfolio.
I plan to go for an average duration of 12 years. I may use the funds/etfs on the list or I may do a non-rolling individual TIPS ladder. I'm listening and learning.
pascalwager
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Re: Bonds in taxable

Post by pascalwager »

hudson wrote: Fri Jul 09, 2021 5:53 am
pascalwager wrote: Thu Jul 08, 2021 10:50 pm
hudson wrote: Fri Jul 02, 2021 1:32 pm
pascalwager wrote: Sun Jan 19, 2020 9:50 pm I'm using VAIPX, the intermediate-term TIPS fund, to better match my investment horizon compared to the short-term version. Actually, I'd like a few years longer duration, but such is not available at Vanguard.
You probably already know about longer TIPS ETFs like
SWRSX...https://www.schwabassetmanagement.com/r ... fact-sheet
and
LTPZ...https://www.pimco.com/en-us/investments ... raded-fund
Yes, I've since been using a combination of SCHP, VAIPX, LTPZ, and S.T.I.G. to better match my investment horizon.
(I see that this is a resurrected discussion from Jan. 2020.)
The first 3 in your list are on my list for a future project in Jan. 2024. I will be 76 and am planning to create a liability matching portfolio.
I plan to go for an average duration of 12 years. I may use the funds/etfs on the list or I may do a non-rolling individual TIPS ladder. I'm listening and learning.
I'm nearly age 79 and I'm using the SS life expectancy for bonds duration/investment horizon (8.82 years for age 79).

S.T.I.G. was the best choice in one account, otherwise I'd have 100% TIPS--I don't have the SS COLA.
hudson
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Re: Bonds in taxable

Post by hudson »

pascalwager wrote: Fri Jul 09, 2021 11:45 pm
I'm nearly age 79 and I'm using the SS life expectancy for bonds duration/investment horizon (8.82 years for age 79).

S.T.I.G. was the best choice in one account, otherwise I'd have 100% TIPS--I don't have the SS COLA.
I looked at the Social Security chart for someone 73 1/2 and got about 12 years. https://www.ssa.gov/oact/STATS/table4c6.html
I ran Boglehead contributor Vineviz's formula for age 74 (using 95 as age at death) and got 10.5 years. viewtopic.php?p=5207938#p5207938
pascalwager
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Re: Bonds in taxable

Post by pascalwager »

hudson wrote: Sat Jul 10, 2021 6:02 am
pascalwager wrote: Fri Jul 09, 2021 11:45 pm
I'm nearly age 79 and I'm using the SS life expectancy for bonds duration/investment horizon (8.82 years for age 79).

S.T.I.G. was the best choice in one account, otherwise I'd have 100% TIPS--I don't have the SS COLA.
I looked at the Social Security chart for someone 73 1/2 and got about 12 years. https://www.ssa.gov/oact/STATS/table4c6.html
I ran Boglehead contributor Vineviz's formula for age 74 (using 95 as age at death) and got 10.5 years. viewtopic.php?p=5207938#p5207938
I agree with your 12 years. (Vineviz has access to some alternate insurance company tables.)

If you double 12 years and add it to age 76, you get terminal age 100. For me, if I double 8.82 and add it to age 79, I get terminal age 96.6.
hudson
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Re: Bonds in taxable

Post by hudson »

pascalwager wrote: Sat Jul 10, 2021 8:18 am
hudson wrote: Sat Jul 10, 2021 6:02 am
pascalwager wrote: Fri Jul 09, 2021 11:45 pm
I'm nearly age 79 and I'm using the SS life expectancy for bonds duration/investment horizon (8.82 years for age 79).

S.T.I.G. was the best choice in one account, otherwise I'd have 100% TIPS--I don't have the SS COLA.
I looked at the Social Security chart for someone 73 1/2 and got about 12 years. https://www.ssa.gov/oact/STATS/table4c6.html
I ran Boglehead contributor Vineviz's formula for age 74 (using 95 as age at death) and got 10.5 years. viewtopic.php?p=5207938#p5207938
I agree with your 12 years. (Vineviz has access to some alternate insurance company tables.)

If you double 12 years and add it to age 76, you get terminal age 100. For me, if I double 8.82 and add it to age 79, I get terminal age 96.6.
Thanks pascalwager!
I think that vineviz said that you don't have to be exact; being somewhere close is good enough.
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