Total Bond has now underperformed Munis pre-tax since 2001

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000
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Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

Due to recent losses in Total Bond, a buy-and-hold investor in a 0% tax bracket would have gotten better performance from Intermediate Munis than Total Bond since 2001 and every subsequent starting year (until 2023). Obviously higher tax brackets would have seen even greater benefit.

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Last decade performance divergence was even greater:

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source

Of course there are various technical reasons why this occurred, but ultimately this is a very underwhelming result for a fund with a seven year duration.
sycamore
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by sycamore »

Makes me think of Meredith Whitney claiming munis would crash. Oops, not so much.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

sycamore wrote: Thu Jun 08, 2023 7:41 pm Makes me think of Meredith Whitney claiming munis would crash. Oops, not so much.
Apparently not. :)
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

Any way to see that on a real basis?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 3:48 pm Any way to see that on a real basis?
There is an inflation adjusted option under the graph at the links. You can hover over the line to see the value at any point. Both are real negative over the last decade.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 3:50 pm
rockstar wrote: Fri Jun 09, 2023 3:48 pm Any way to see that on a real basis?
There is an inflation adjusted option under the graph at the links. You can hover over the line to see the value at any point. Both are real negative over the last decade.
So between this post and your last one, the only option for intermediate duration bonds is to ladder TIPS because any unforeseen inflation will wipe you out pretax?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 3:57 pm So between this post and your last one, the only option for intermediate duration bonds is to ladder TIPS because any unforeseen inflation will wipe you out pretax?
I'm not sure what the answer is. Laddered TIPS still have tax due on the phantom income from the inflation adjustments.

I think safety is expensive. Maybe it's too much to expect to reliably get 0% real post-tax without any risk?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 4:05 pm
rockstar wrote: Fri Jun 09, 2023 3:57 pm So between this post and your last one, the only option for intermediate duration bonds is to ladder TIPS because any unforeseen inflation will wipe you out pretax?
I'm not sure what the answer is. Laddered TIPS still have tax due on the phantom income from the inflation adjustments.

I think safety is expensive. Maybe it's too much to expect to reliably get 0% real post-tax without any risk?
Why take any duration risk if you can’t be 0% real after taxes?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 4:07 pm Why take any duration risk if you can’t be 0% real after taxes?
Keeping it in cash takes the risk of rates going even lower.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 4:11 pm
rockstar wrote: Fri Jun 09, 2023 4:07 pm Why take any duration risk if you can’t be 0% real after taxes?
Keeping it in cash takes the risk of rates going even lower.
If rates go down, equities should go up.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 4:13 pm If rates go down, equities should go up.
Unless other factors push them more the other way. Rates can go down during a deflationary depression.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by burritoLover »

So, if you were omniscient in 2001, you would have known you'd eventually be better off in munis vs. BND. Got it.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by WillRetire »

2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Beensabu »

WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 4:20 pm
rockstar wrote: Fri Jun 09, 2023 4:13 pm If rates go down, equities should go up.
Unless other factors push them more the other way. Rates can go down during a deflationary depression.
Or should we be taking more risk in credit quality on the bond side? I can’t wrap my head around intentionally losing money. This should also push people to just spend it.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

burritoLover wrote: Fri Jun 09, 2023 4:25 pm So, if you were omniscient in 2001, you would have known you'd eventually be better off in munis vs. BND. Got it.
This is not a trivial result as we are commonly told Munis are priced for higher tax brackets and are a riskier kind of bond. Over the last decade the ~1% return difference, again pre-tax, is as much as the AUM fees Bogleheads rightly avoid. Of course, the sample funds may have had some slight differences in duration and other factors, but are all ultimately the kind of fund commonly suggested as a core holding.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 4:40 pm Or should we be taking more risk in credit quality on the bond side? I can’t wrap my head around intentionally losing money. This should also push people to just spend it.
Well, those certainly seem to be the kinds of incentives at play here.

Obviously recently we have seen how HY yield bonds can provide diversification in rising rates (both due to their higher starting yields and generally overall lower duration).

I think Bogle's argument about Total Bond containing a lot of kinds of bonds that aren't especially suited to an individual investor (e.g. Treasuries held for foreign exchange purposes) is yet another one of his predictions that has come true.

In a portfolio with large non-stock holdings, credit risk does not seem unreasonable to me. It is a different kind of risk than risks like term, sovereign default, and corporate underperformance of expectations but not enough to default. However I'm not sure if indexing credit is the right approach; it seems analogous to a bank that lends the most to the debtor that asks for the most debt. I will also note a fund like BND has a credit cut off floor while something like IUSB doesn't (at least among tradable bonds).
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rebellovw »

Too bad the blue chart will never resume its upward trend....interest rates only go up and nothing ever changes.

Oh well...
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by burritoLover »

000 wrote: Fri Jun 09, 2023 4:57 pm
burritoLover wrote: Fri Jun 09, 2023 4:25 pm So, if you were omniscient in 2001, you would have known you'd eventually be better off in munis vs. BND. Got it.
This is not a trivial result as we are commonly told Munis are priced for higher tax brackets and are a riskier kind of bond. Over the last decade the ~1% return difference, again pre-tax, is as much as the AUM fees Bogleheads rightly avoid. Of course, the sample funds may have had some slight differences in duration and other factors, but are all ultimately the kind of fund commonly suggested as a core holding.
It’s not trivial but doesn’t tell you munis are a better choice than BND going forward - not sure if you were specifically saying that or not. It’s not indicative of any systematic change.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 5:04 pm
rockstar wrote: Fri Jun 09, 2023 4:40 pm Or should we be taking more risk in credit quality on the bond side? I can’t wrap my head around intentionally losing money. This should also push people to just spend it.
Well, those certainly seem to be the kinds of incentives at play here.

Obviously recently we have seen how HY yield bonds can provide diversification in rising rates (both due to their higher starting yields and generally overall lower duration).

I think Bogle's argument about Total Bond containing a lot of kinds of bonds that aren't especially suited to an individual investor (e.g. Treasuries held for foreign exchange purposes) is yet another one of his predictions that has come true.

In a portfolio with large non-stock holdings, credit risk does not seem unreasonable to me. It is a different kind of risk than risks like term, sovereign default, and corporate underperformance of expectations but not enough to default. However I'm not sure if indexing credit is the right approach; it seems analogous to a bank that lends the most to the debtor that asks for the most debt. I will also note a fund like BND has a credit cut off floor while something like IUSB doesn't (at least among tradable bonds).
They usually say to take risk on the equity side, not the bond side. But investment grade bonds don’t keep up with inflation after taxes. I can see their value in retirement with a lower tax bracket. But they seem a drag during peak earnings years. This would counter the bonds in years argument. It’s more a function of tax bracket than age.

As for munis I’d agree that one percent difference is a function of credit risk. Of course, if you look at the Fed’s chairman’s portfolio it’s heavily invested in individual munis.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by WillRetire »

Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
True. But bond funds usually distinguish between the two because one works well in taxable (municipal bond funds) and the other works well in non-taxable (total bond).
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

rockstar wrote: Fri Jun 09, 2023 5:12 pm As for munis I’d agree that one percent difference is a function of credit risk.
It was the opposite in the past.

Total Bond vs. IT Munis 1987 - 2000

LT Corporates, Treasuries, and Munis 1978 - 2000

ST Corporates, Treasuries, and Munis 1983 - 2000

I wonder how much of the difference is due to munis being more attractive when yields and tax rates were higher.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Northern Flicker »

VWIUX (intermediate munis) has a duration of 4.7 years vs over 6 years for total bond. This will create a recent performance gap after a run up in interest rates.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by rockstar »

000 wrote: Fri Jun 09, 2023 5:53 pm
rockstar wrote: Fri Jun 09, 2023 5:12 pm As for munis I’d agree that one percent difference is a function of credit risk.
It was the opposite in the past.

Total Bond vs. IT Munis 1987 - 2000

LT Corporates, Treasuries, and Munis 1978 - 2000

ST Corporates, Treasuries, and Munis 1983 - 2000

I wonder how much of the difference is due to munis being more attractive when yields and tax rates were higher.
Tax rates were definitely higher during that period but so was inflation. However, it was more difficult to invest during that period of time. It's been much easier over the last two decades. And 401Ks weren't a thing back then.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

Northern Flicker wrote: Fri Jun 09, 2023 6:13 pm VWIUX (intermediate munis) has a duration of 4.7 years vs over 6 years for total bond. This will create a recent performance gap after a run up in interest rates.
Using current durations stated for VWITX, VWLTX, and BND I created a muni allocation with the same duration as BND.

Got even better results for the munis:

https://www.portfoliovisualizer.com/bac ... ion3_3=100

https://www.portfoliovisualizer.com/bac ... ion3_3=100

https://www.portfoliovisualizer.com/bac ... ion3_3=100

Again, all pre-tax.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by martincmartin »

rockstar wrote: Fri Jun 09, 2023 5:12 pm This would counter the bonds in years argument.
There is no "hold your age on bonds" argument. Someone said it once, and everybody started repeating it, until it became something everyone agreed but nobody actually evaluated.

If you back test it, you find it works worse than a fixed AA in retirement.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by tixoboy »

This is a significant finding, and I'm having trouble wrapping my head around how this can be the case. Municipal bonds usually really do (as far as I can tell) offer lower yields at issue compared to other types of bonds given their relative tax efficiency, and I usually assume the market is able to price everything correctly... except not?

How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by comeinvest »

Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
The tides turn when you add equities to the mix - treasuries start to shine: https://www.portfoliovisualizer.com/bac ... tion4_3=60
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by comeinvest »

000 wrote: Fri Jun 09, 2023 7:34 pm
Northern Flicker wrote: Fri Jun 09, 2023 6:13 pm VWIUX (intermediate munis) has a duration of 4.7 years vs over 6 years for total bond. This will create a recent performance gap after a run up in interest rates.
Using current durations stated for VWITX, VWLTX, and BND I created a muni allocation with the same duration as BND.

Got even better results for the munis:

https://www.portfoliovisualizer.com/bac ... ion3_3=100

https://www.portfoliovisualizer.com/bac ... ion3_3=100

https://www.portfoliovisualizer.com/bac ... ion3_3=100

Again, all pre-tax.
How exactly did you do it?
Muni-treasury-ratios: Intermediate-term munis typically trade at about 65% of treasuries yield of the same maturity; long-term munis at about 90% of treasuries yield of the same maturity.
So an ITM (intermediate-term muni bond) has only 65% of the interest rate sensitivity (interest rate risk) of an ITM (intermediate-term treasury bond) of the same duration, or not?
That assumes that the duration numbers were not already adjusted for the different sensitivities (risks). Duration (definition): sensitivity with respect to a 1% change in yield. I assume that refers to the yield of the bond in question; not to the yield of treasuries or something else. If true, then duration risk alone wouldn't reflect interest rate risk, as in (interest rate risk definition:) risk that risk-free rates rise by 1%.

To answer your original question, it would be interesting to find out what was the M/T ratio in 2001 vs. now, and adjust for that effect if it changed.
Last edited by comeinvest on Tue Jun 13, 2023 6:34 am, edited 1 time in total.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by skeptical »

tixoboy wrote: Tue Jun 13, 2023 2:39 am This is a significant finding, and I'm having trouble wrapping my head around how this can be the case. Municipal bonds usually really do (as far as I can tell) offer lower yields at issue compared to other types of bonds given their relative tax efficiency, and I usually assume the market is able to price everything correctly... except not?

How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
I have known this for quite some time, as I have most of my bonds in munis, with "tax favored" accounts having total bond, and all of my bonds in taxable are munis.

Conventional wisdom is that muni bonds have more risk and less dividends, and are only for those in high tax brackets. However, what is usually not considered is:

- Muni's, historically, have very low default rates, especially when you buy AAA/AA, much lower than corporates. So, far, they have not been riskier in the sense of actual loss, but that could change.
- The federal government has supported munis whenever there is a crisis, at least indirectly by leaving large amounts of money on the doorsteps of local governments that they do noit even know how to spend.
- When taxes are rising, or there is the threat of that happening, munis become even more in demand.
- Munis are very useful for lowering your marginal tax bracket, so the conventional wisdom of them being useful for the highest of the marginal rates is flawed, in my opinion. They can be useful for a wide range of tax situations, I find that the "after tax" rate is higher than what you would think.
- TLH harvesting works great with munis, especially since muni's are more volatile in a crisis.
- Munis did really well, relatively, during the "unexpected" inflation we have had.
- Muni's are typically held by wealthier than average investors for the long term, which provides some longer term stability
- Supply of munis is more related to the real world - a local government does not simply issue a muni for trivial purposes, there needs to be something to be built that is useful (for the most part). Supply is more constrained, and is "felt more" by the local community.

While not everyone would agree with each of these points, and many are not as "actionable" as people here would like to see, I think that there are a lot of tailwinds for munis that are not generally appreciated. You need to evaluate munis not just by your marginal tax rate, but how they affect your entire portfolio over time, including overall household tax savings and TLH opportunities over time.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by comeinvest »

skeptical wrote: Tue Jun 13, 2023 6:33 am - TLH harvesting works great with munis, especially since muni's are more volatile in a crisis.
Can you please elaborate? Isn't TLH with bonds (including munis) a zero-sum game in the long run? Every bond matures, and interest rates mean-revert by nature. So in the long run you could only generate net losses if you sell low and don't reinvest, something that would certainly defeat the purpose, right?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by coachd50 »

skeptical wrote: Tue Jun 13, 2023 6:33 am
tixoboy wrote: Tue Jun 13, 2023 2:39 am This is a significant finding, and I'm having trouble wrapping my head around how this can be the case. Municipal bonds usually really do (as far as I can tell) offer lower yields at issue compared to other types of bonds given their relative tax efficiency, and I usually assume the market is able to price everything correctly... except not?

How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
I have known this for quite some time, as I have most of my bonds in munis, with "tax favored" accounts having total bond, and all of my bonds in taxable are munis.

Conventional wisdom is that muni bonds have more risk and less dividends, and are only for those in high tax brackets. However, what is usually not considered is:

- Muni's, historically, have very low default rates, especially when you buy AAA/AA, much lower than corporates. So, far, they have not been riskier in the sense of actual loss, but that could change.
- The federal government has supported munis whenever there is a crisis, at least indirectly by leaving large amounts of money on the doorsteps of local governments that they do noit even know how to spend.
- When taxes are rising, or there is the threat of that happening, munis become even more in demand.
- Munis are very useful for lowering your marginal tax bracket, so the conventional wisdom of them being useful for the highest of the marginal rates is flawed, in my opinion. They can be useful for a wide range of tax situations, I find that the "after tax" rate is higher than what you would think.
- TLH harvesting works great with munis, especially since muni's are more volatile in a crisis.
- Munis did really well, relatively, during the "unexpected" inflation we have had.
- Muni's are typically held by wealthier than average investors for the long term, which provides some longer term stability
- Supply of munis is more related to the real world - a local government does not simply issue a muni for trivial purposes, there needs to be something to be built that is useful (for the most part). Supply is more constrained, and is "felt more" by the local community.

While not everyone would agree with each of these points, and many are not as "actionable" as people here would like to see, I think that there are a lot of tailwinds for munis that are not generally appreciated. You need to evaluate munis not just by your marginal tax rate, but how they affect your entire portfolio over time, including overall household tax savings and TLH opportunities over time.
Related to affecting ones entire portfolio - there is a small slice of the investing population who sit right on the edge of the biggest marginal tax bracket jump (currently 12% to 22%). I would suggest that investors not just assume thst munis are for “the rich” and instead do the actual math to see if they might benefit their individual portfolio because of this potential jump if other investments are utilized instead.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by ClevrChico »

WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Great point. The under-performance would only be realized if you sell now. I expect things to look different in a few years. Intermediate Muni's and Total Bond are different products anyway.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by wolf359 »

According to your investment policy statement, what is the role of bonds in your portfolio? How much do you have? What type of bond did you select? Why did you pick that one?

Bonds are essentially a contract in which you loan money for a period of time, in return for interest. Although the principal value of the bond can fluctuate based on the changes in interest rate, bonds provide stability. If you buy $100,000 of bonds, you will get $100,000 back at the end of the contract (with interest paid depending on the terms of the bond.)

All three bond types you show in your chart behaved similarly. Although there are differences in performance and volatility, they're all very close to each other.

If you're focusing solely on performance, I would note that you probably would have preferred Total Bond over munis in every year except this year. If you're not liquidating your portfolio this year, then Total Bond is still probably the better choice because of its consistency of performance year after year.

As for the comment about risk, the question is which one are you considering? When considering bonds, the main risks are listed below (source: drawn from investopedia - there's a more extensive article there)

Risk #1: Interest rate risk. When interest rates fall, bond prices rise.
Risk #2: Reinvestment risk. Having to reinvest proceeds at a lower rate than what the funds were previously earning.
Risk #3: Inflation risk. When inflation increases dramatically, bonds can have a negative rate of return.
Risk #4: Credit risk. Corporate bonds depend on the issuer's ability to repay the debt, so there is always the possibility of default of payment.
Risk #5: Credit rating risk. Changes in the organization's credit rating may cause higher interest rates on loans and therefore impact bondholders.
Risk #6: Liquidity risk. Low liquidity in some bonds can cause price volatility.

Recent political games with the federal debt limit has increased the perception of risk in Treasuries, which is probably related to the recent fall in relative prices (but note that all bonds fell due to interest rate risk). Even so, Treasuries are still considered much less risky than corporate or municipal bonds. Treasuries are backed by the full faith and credit of the U.S. government (which also has the ability to print money). Compare that risk to something backed by even a strong company like Apple, or, say, a bond issued by the City of Detroit.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by skeptical »

comeinvest wrote: Tue Jun 13, 2023 6:40 am
skeptical wrote: Tue Jun 13, 2023 6:33 am - TLH harvesting works great with munis, especially since muni's are more volatile in a crisis.
Can you please elaborate? Isn't TLH with bonds (including munis) a zero-sum game in the long run? Every bond matures, and interest rates mean-revert by nature. So in the long run you could only generate net losses if you sell low and don't reinvest, something that would certainly defeat the purpose, right?
You are correct - in the long run,in theory, it does not matter, but taxes are not "smooth", and if you can control how/when you use and generate the losses/gains, you can come out ahead.

In my particular case, I have banked losses three times in 10 years, and taken gains twice, and offset other gains twice. I only use bond funds. I am also retired, living almost on dividends/interest, all dividends qualified, and all interest muni. Therefor, I have a lot of flexibility in deciding what/when to sell to leverage the zero cap gains bucket. So I dispense gains sometimes for close to nothing (just state tax) when I can, and use losses when I have large expenses.

- I try to use the gains in lower tax years (tax gain harvesting), for example, when I still have free space in the zero-cap gains stack. I have been able to sneak this in a couple of years, especially recently as dividends from VTI has shrunk. I only pay state tax on this.
- I try to use the losses during the higher tax years, for example, rebalancing equities after a run up (and creating zero basis bonds), dumping equities when paying off college tuition for two kids (trying to lumping together a couple of years), etc.
- I have banked my recent losses from the last year, hoping to use them if/when we sell our house and reduce cap gains on that sale. This is potentially a huge tax gain, but might get dissipated by years of $3K forced usage of gains.
- If interest rates revert, and my bonds go up in value and have a lot of latent gains, I will try to not sell them, unless that is cheaper tax wise than selling equities, which is still somewhat of a win.
- Hopefully, I will leave appreciated bond funds to my kids.

So, overall, if taxes were "smooth", its zero sum. However, if you control the realization of gains and losses, you can come out ahead, and since, life is short, maybe get a step up.

I estimate that I have gotten an extra .2% a year in benefit from just TLH, or almost a 10% boost in income from my bond side, which is well over 50% of my income from a 50/50 portfolio. It won't change my life, and it might not sound huge, but with a little planning and work, I'll take it. This i in addition to all the other benefit I get from the munis.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by NiceUnparticularMan »

tixoboy wrote: Tue Jun 13, 2023 2:39 am This is a significant finding, and I'm having trouble wrapping my head around how this can be the case. Municipal bonds usually really do (as far as I can tell) offer lower yields at issue compared to other types of bonds given their relative tax efficiency, and I usually assume the market is able to price everything correctly... except not? How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
It is because otherwise-comparable taxable bonds predictably tend to experience a much higher market price drop than munis when there is a large market interest rate increase. If you go through the mathematics of yield and price dynamics, this is actually a predictable consequence of taxable bonds having yields that are high-tax-rate-equivalent to munis. If you like, the ratio of taxable bond yields to muni bond yields necessary to maintain tax equivalency acts as an amplifier of market interest rate changes for taxable bonds (or, equivalently, acts as a dampener for munis).

And so you can see that happening in the chart when market interest rates increased. Otherwise comparable munis dropped much less in market price than taxable bonds, and so now are ahead in total returns.

It works the other way too, incidentally. If market interest rates drop, otherwise-comparable nominal bonds will tend to experience a higher market price increase than munis. From 2007 through 2011 or so, for example, there was a significant overall drop in market interest rates. And the comparison between these funds looks like this in that period:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

Same deal from late 2018 through mid-2020. Big market interest rate drop, and in that specific period otherwise comparable nominal bonds got a big capital gain versus munis:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

But of course capital gains and losses are not the part of muni returns that are tax-protected. This appears to be a surprise to some people, but it was always the case the tax equivalence of munis only applied to the taxable income, not the capital returns/losses.

And in fact, I am quite confident if you tracked through just the taxable income on otherwise-comparable nominal bond fund shares bought at the same time as muni fund shares, you would see the expected tax equivalencies as to that component of their returns.

But the capital gains and losses part of their returns are taxed the same, and also the capital gains and losses part of their returns can be quite different in circumstances like what happened recently. And here we are.

What this chart is really showing, therefore, is that as of mid-2020, the net effect of these capital gain/loss periods had ended up with Total Bond ahead of roughly comparable munis in terms of total returns, assuming zero tax rates and reinvested income. But the recent market interest rate increase was so dramatic it was enough to put munis ahead. And again, all that is untethered to tax equivalency, because tax equivalency does not apply to capital gains/losses.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Florida Orange »

Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
Munis can be a little risky if a substantial amount of your bonds are issued by a single municipality. But in a broad based municipal bond fund I don't think they're any riskier than Treasuries.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Beensabu »

comeinvest wrote: Tue Jun 13, 2023 6:17 am
Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
The tides turn when you add equities to the mix - treasuries start to shine: https://www.portfoliovisualizer.com/bac ... tion4_3=60
Yeah, it looks like that's entirely due to the 2000-2002 bear, because see what happens when you start in 2003? So treasuries were a better diversifier for equities during that particular downturn.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Beensabu
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Beensabu »

Florida Orange wrote: Tue Jun 13, 2023 11:57 am
Beensabu wrote: Fri Jun 09, 2023 4:40 pm The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
Munis can be a little risky if a substantial amount of your bonds are issued by a single municipality. But in a broad based municipal bond fund I don't think they're any riskier than Treasuries.
Yeah, they sure don't seem to have been any riskier.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by comeinvest »

Beensabu wrote: Tue Jun 13, 2023 12:48 pm
comeinvest wrote: Tue Jun 13, 2023 6:17 am
Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
The tides turn when you add equities to the mix - treasuries start to shine: https://www.portfoliovisualizer.com/bac ... tion4_3=60
Yeah, it looks like that's entirely due to the 2000-2002 bear, because see what happens when you start in 2003? So treasuries were a better diversifier for equities during that particular downturn.
Also 2007-2009 and 2020, right? Pretty much every major market meltdown. The portfolio with treasuries still had higher sharpe ratio and less max drawdown since 2003.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Beensabu »

comeinvest wrote: Tue Jun 13, 2023 1:56 pm
Beensabu wrote: Tue Jun 13, 2023 12:48 pm
comeinvest wrote: Tue Jun 13, 2023 6:17 am
Beensabu wrote: Fri Jun 09, 2023 4:40 pm
WillRetire wrote: Fri Jun 09, 2023 4:26 pm 2022 was the worst year for bonds in the 4 decades since I've been an investor. Therefore, I will not be measuring bonds' RoR vs. other asset classes with a recent endpoint. That would be like measuring stocks' RoR as of March 2009 vs. bonds.
Munis are also bonds. They're municipal bonds.

Intermediate-term munis are just the tax efficient Total Bond substitute for a taxable account. 3.51% vs. 3.49% CAGR over 20+ years is pretty much the same thing.

The interesting bit is that they were theoretically supposed to be riskier than treasuries, but that doesn't seem to have been the case at all by literally any of the normal measures.
The tides turn when you add equities to the mix - treasuries start to shine: https://www.portfoliovisualizer.com/bac ... tion4_3=60
Yeah, it looks like that's entirely due to the 2000-2002 bear, because see what happens when you start in 2003? So treasuries were a better diversifier for equities during that particular downturn.
Also 2007-2009 and 2020, right? Pretty much every major market meltdown. The portfolio with treasuries still had higher sharpe ratio and less max drawdown since 2003.
I dunno. They all look pretty much the same if you start in 2003. Perhaps treasuries are a better diversifier / more helpful in a prolonged equity drawdown?
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
NiceUnparticularMan
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by NiceUnparticularMan »

comeinvest wrote: Tue Jun 13, 2023 1:56 pm Also 2007-2009 and 2020, right? Pretty much every major market meltdown. The portfolio with treasuries still had higher sharpe ratio and less max drawdown since 2003.
Yeah, as a general rule, otherwise comparable Treasuries are likely to be better stock diversifiers than munis in a disinflationary stock crisis, because in a disinflationary stock crisis, likely market interest rates are going to go down. And as discussed before, in such circumstances likely Treasuries will experience higher capital gains than otherwise comparable munis. Which means you will likely have more ability to sell Treasuries to "rebalance" into stocks.

However, it is important to know that not all stock crises are disinflationary, and indeed although less common, some of the worst can be inflationary instead. We had not seen a serious inflationary stock crisis in the US for a while, but we finally got one recently. And of course we got one back in the 1970s as well.

So as usual, I would advise stepping back and asking what purpose your bonds are supposed to be serving.

If it is to act as a risky bond that you think will serve as a useful stock diversifier in risky portfolios still deep in accumulation, probably Treasuries over munis is a good idea.

If it is to moderate sequence of real returns risk in the danger zone around retirement--nominal Treasuries are not necessarily an ideal choice. I'd actually nominate liability-matched TIPS instead of munis. But munis will likely be a bit better bet than nominal Treasuries because inflationary stock crises generally are the bigger danger when it comes to sequence of real returns risk.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by BrooklynInvest »

coachd50 wrote: Tue Jun 13, 2023 6:44 am How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
Duration? Wouldn't the max drawdown indicate one's significant'y longer than the other?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by coachd50 »

BrooklynInvest wrote: Tue Jun 13, 2023 3:28 pm
coachd50 wrote: Tue Jun 13, 2023 6:44 am How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
Duration? Wouldn't the max drawdown indicate one's significant'y longer than the other?
I think you misattributed that quote. I didn't ask that.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by tixoboy »

NiceUnparticularMan wrote: Tue Jun 13, 2023 9:01 am
tixoboy wrote: Tue Jun 13, 2023 2:39 am This is a significant finding, and I'm having trouble wrapping my head around how this can be the case. Municipal bonds usually really do (as far as I can tell) offer lower yields at issue compared to other types of bonds given their relative tax efficiency, and I usually assume the market is able to price everything correctly... except not? How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
It is because otherwise-comparable taxable bonds predictably tend to experience a much higher market price drop than munis when there is a large market interest rate increase. If you go through the mathematics of yield and price dynamics, this is actually a predictable consequence of taxable bonds having yields that are high-tax-rate-equivalent to munis. If you like, the ratio of taxable bond yields to muni bond yields necessary to maintain tax equivalency acts as an amplifier of market interest rate changes for taxable bonds (or, equivalently, acts as a dampener for munis).

And so you can see that happening in the chart when market interest rates increased. Otherwise comparable munis dropped much less in market price than taxable bonds, and so now are ahead in total returns.

It works the other way too, incidentally. If market interest rates drop, otherwise-comparable nominal bonds will tend to experience a higher market price increase than munis. From 2007 through 2011 or so, for example, there was a significant overall drop in market interest rates. And the comparison between these funds looks like this in that period:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

Same deal from late 2018 through mid-2020. Big market interest rate drop, and in that specific period otherwise comparable nominal bonds got a big capital gain versus munis:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

But of course capital gains and losses are not the part of muni returns that are tax-protected. This appears to be a surprise to some people, but it was always the case the tax equivalence of munis only applied to the taxable income, not the capital returns/losses.

And in fact, I am quite confident if you tracked through just the taxable income on otherwise-comparable nominal bond fund shares bought at the same time as muni fund shares, you would see the expected tax equivalencies as to that component of their returns.

But the capital gains and losses part of their returns are taxed the same, and also the capital gains and losses part of their returns can be quite different in circumstances like what happened recently. And here we are.

What this chart is really showing, therefore, is that as of mid-2020, the net effect of these capital gain/loss periods had ended up with Total Bond ahead of roughly comparable munis in terms of total returns, assuming zero tax rates and reinvested income. But the recent market interest rate increase was so dramatic it was enough to put munis ahead. And again, all that is untethered to tax equivalency, because tax equivalency does not apply to capital gains/losses.
This explanation makes a lot of sense - thanks!

Put another way, the fact that Munis are currently outperforming total bonds is really nothing but a reflection of the current market conditions with significant interest rate increases over a relatively short period of time. There may or may not be anything of value to take away from this observation.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by NiceUnparticularMan »

tixoboy wrote: Tue Jun 13, 2023 8:03 pm Put another way, the fact that Munis are currently outperforming total bonds is really nothing but a reflection of the current market conditions with significant interest rate increases over a relatively short period of time. There may or may not be anything of value to take away from this observation.
I'd say it is generally good to understand what constitutes total returns for bond funds, and what that can mean for muni funds versus otherwise comparable bond funds in different interest rate scenarios. That's not going to tell you whether munis are better/worse than comparable nominal bonds, but hopefully it will help people understand that the tax equivalence only applies to the taxable income, which I believe is a good thing to really grasp.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by BrooklynInvest »

coachd50 wrote: Tue Jun 13, 2023 5:04 pm
BrooklynInvest wrote: Tue Jun 13, 2023 3:28 pm
coachd50 wrote: Tue Jun 13, 2023 6:44 am How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
Duration? Wouldn't the max drawdown indicate one's significant'y longer than the other?
I think you misattributed that quote. I didn't ask that.
You're right - apologies! I deleted... something incorrectly. Will try and fix.
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by BrooklynInvest »

BrooklynInvest wrote: Tue Jun 13, 2023 3:28 pm
tixoboy wrote: Tue Jun 13, 2023 2:39 am How can we explain the underperformance by total US bond market relative to intermediate tax-exempt?
Duration? Wouldn't the max drawdown indicate one's significant'y longer than the other?
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by Electron »

I also was surprised at the relative performance comparison going back to 2001.

One thing to note is that the composition of the Total Bond Market Index has changed quite a bit over time. The weighting in Treasury Bonds has increased and the duration has also increased.

https://www.thrivent.com/literature/29311.pdf

The duration in October 2011 was 5.1 versus 6.5 today. I thought I had some earlier data but was not able to find it.

Note also that over 20% of the Total Bond Market fund is currently in Mortgage Securities. The duration on mortgage bonds generally increases when rates are rising as a result of fewer prepayments.

Lastly, I added Vanguard Long-Term Investment-Grade to the comparison just out of curiosity. The relative performance in this comparison is quite a surprise.

https://www.portfoliovisualizer.com/bac ... ion3_3=100
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Re: Total Bond has now underperformed Munis pre-tax since 2001

Post by 000 »

Electron wrote: Wed Jun 14, 2023 5:04 pm Lastly, I added Vanguard Long-Term Investment-Grade to the comparison just out of curiosity. The relative performance in this comparison is quite a surprise.

https://www.portfoliovisualizer.com/bac ... ion3_3=100
That is interesting. LT Corporates also just beat LT Treasuries by 1% over that time, opposite of the preceding two decades.

https://www.portfoliovisualizer.com/bac ... ion2_2=100

https://www.portfoliovisualizer.com/bac ... ion2_2=100
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