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Municipal bonds in taxable account: concentration risk?

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  • Live Free MD Live Free MD 
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    Earnest refinancing bonus

    Approximately 90% of my savings are in a taxable brokerage account.

    I have a low to moderate willingness to take risk so my asset allocation is approximately 50% stocks with the rest in municipal bonds.

    Despite the tax concerns, would it be advantageous to diversify into treasury bonds or a total bond market index fund in my taxable account?

    I am currently in a high tax bracket (hence the choice for municipal bonds), but I expect this to decrease in the future.

    Thank you for your thoughts.

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244727 Reply
    Avatar Peds 
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    Meh probably not.
    Ibonds.
    No 401k?

    #244731 Reply
    Live Free MD Live Free MD 
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    Meh probably not.
    Ibonds.
    No 401k?

    Click to expand…

    I am maxing out a 401k, but the total amount in the 401k is only a very small part of my total savings.  Even if I filled the 401k with 100% bonds, it would not be enough to maintain my desired asset allocation.

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244749 Reply
    Avatar ZZZ 
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    You’re presumably young, given your small portion of savings in tax deferred accounts. Why have you chosen the asset allocation of a 70 year old?

    You think munis are low risk? Have you looked into the finances behind the munis you own…with healthcare and pension obligations, it ain’t pretty.

    #244753 Reply
    Live Free MD Live Free MD 
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    You’re presumably young, given your small portion of savings in tax deferred accounts. Why have you chosen the asset allocation of a 70 year old?

    You think munis are low risk? Have you looked into the finances behind the munis you own…with healthcare and pension obligations, it ain’t pretty.

    Click to expand…

    Thank you for the feedback.

    With regard to your first question, every investor needs to decide how much risk they are comfortable with.  I am comfortable with 50% stocks.  This would correspond to a 25% drop in net worth in a 2007-2009 scenario.

    As for the second question, I completely accept that I do not understand the risk of municipal bonds.  If they are risker than I thought, then perhaps this would be an argument to ditch the municipal bonds and switch to treasury bonds or a total bond market fund.

     

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244757 Reply
    Avatar Larry Ragman 
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    Live Free MD, individual municipal bonds represent a specific risk of failure if the municipality goes bankrupt. State bonds, like federal, are protected by the taxing power of the sovereign. An intermediate term muni index fund is probably fine because its risk is diversified across all localities (e.g., states, municipal, civic projects, etc.) Either way you face an interest rate risk, but that is always going to be there and I do not think anyone considers the risk to be so great as to keep out of the investment class. It is possible to calculate the tax rate at which taxable bonds yield better returns than munis, but my guess is that is unlikely to affect you unless you give up your doctor income before you have the resources to retire at the same standard of living. If I were you, given the constraints you set out, I’d fill my 401k with a total bond fund, then hold sufficient funds in an intermediate term muni index fund to achieve your desired AA.

    Sidebar: try to create more tax deferred space…

    Good luck!

    #244770 Reply
    Liked by Tim, angeladiaz99
    Avatar ZZZ 
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    “I am comfortable with 50% stocks.  This would correspond to a 25% drop in net worth in a 2007-2009 scenario.”

    Sure, drops are bad, but again, you’re presumably young…do you anticipate long term trends in stocks outperforming bonds to change over your investing lifetime?

    Sure, 2007-2009 was bad for equities. But 2009-2019 has been great.

    Since 2/1/09, SPY total return has been 15.12% annualized; MUB has been 4.26% annualized. Poor returns are a risk if you’re too conservative.

    Sure, starting in 2009 is cherry picking. So lets go back and include 2007-2009 since that’s your stated worry. We’ll start at 9/10/07, close enough to pre-crash peak for this. SPY total return since then, 8.01% annualized; MUB since then, 4.15% annualized.

    Just food for thought if you have a long investment time horizon, as you presumably do.

    #244775 Reply
    Live Free MD Live Free MD 
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    “I am comfortable with 50% stocks.  This would correspond to a 25% drop in net worth in a 2007-2009 scenario.”

    Sure, drops are bad, but again, you’re presumably young…do you anticipate long term trends in stocks outperforming bonds to change over your investing lifetime?

    Sure, 2007-2009 was bad for equities. But 2009-2019 has been great.

    Since 2/1/09, SPY total return has been 15.12% annualized; MUB has been 4.26% annualized. Poor returns are a risk if you’re too conservative.

    Sure, starting in 2009 is cherry picking. So lets go back and include 2007-2009 since that’s your stated worry. We’ll start at 9/10/07, close enough to pre-crash peak for this. SPY total return since then, 8.01% annualized; MUB since then, 4.15% annualized.

    Just food for thought if you have a long investment time horizon, as you presumably do.

    Click to expand…

    I think many investors overestimate their risk tolerance.

    According to Benjamin Graham, in the Intelligent Investor:

    “We recommended that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75%, with the converse being necessarily true for the common-stock component; that his simplest choice would be to maintain a 50–50 proportion between the two.”

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244780 Reply
    Live Free MD Live Free MD 
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    Live Free MD, individual municipal bonds represent a specific risk of failure if the municipality goes bankrupt. State bonds, like federal, are protected by the taxing power of the sovereign. An intermediate term muni index fund is probably fine because its risk is diversified across all localities (e.g., states, municipal, civic projects, etc.) Either way you face an interest rate risk, but that is always going to be there and I do not think anyone considers the risk to be so great as to keep out of the investment class. It is possible to calculate the tax rate at which taxable bonds yield better returns than munis, but my guess is that is unlikely to affect you unless you give up your doctor income before you have the resources to retire at the same standard of living. If I were you, given the constraints you set out, I’d fill my 401k with a total bond fund, then hold sufficient funds in an intermediate term muni index fund to achieve your desired AA.

    Sidebar: try to create more tax deferred space…

    Good luck!

    Click to expand…

    Thank you for the background on municipal bonds.  Is your conclusion that municipal bonds are quite safe?

    I max out my employer 401k, individual and spousal Roth IRA, individual 401k, and my wife’s HSA.  Unfortunately, I do not see any other opportunities for tax-deferred space.

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244781 Reply
    Avatar Larry Ragman 
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    The class is safe enough. I can’t speak to any individual bonds you might hold.

    Does your 401k allow the mega backdoor Roth (use after tax contributions up to $56k, less yours and your employers contributions, and in service transfers to your iRoth)? Not all plans do, but if so it is a great way to create more space.

    #244800 Reply
    Avatar StarTrekDoc 
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    Munis are a fine vehicle in taxable.  If you’re in CA or NY even more reason for it in taxable while letting your stock equities sit in the tax deferred — this is most tax efficient/least drag you can have — especially if at higher brackets.

    Being 50/50 is fine.  Conservative, but fine.  nothing wrong in that.  Some people have $50-100k just sitting in a CD and that’s fine too.  To each their own based on what their IPS guides them to do.

    We currently ~$200k in munis in our taxable account and perfectly happy with that since it represents about 50% of the mortgage pay-off fund that we have and tilted conservatively because of that.

    #244801 Reply
    Liked by Vagabond MD
    Avatar DCdoc 
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    If you’re setting aside approximately $70k in tax deferred per year, and that only represents 10% (90% in taxable) it would imply that you have a huge income. Nothing wrong with muni’s but they have both interest rate risk and potential default risk. If you’re dead set on a high proportion of bonds, consider TIPS or other governmental bonds to diversify your bond holdings.

    #244802 Reply
    Live Free MD Live Free MD 
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    The class is safe enough. I can’t speak to any individual bonds you might hold.

    Does your 401k allow the mega backdoor Roth (use after tax contributions up to $56k, less yours and your employers contributions, and in service transfers to your iRoth)? Not all plans do, but if so it is a great way to create more space.

    Click to expand…

    I’m simply invested in the Vanguard intermediate tax-exempt fund.

    Unfortunately, my employer 401k does not allow after tax contributions to the plan.

    Sports Medicine Physician. Athlete. Big Mountain Enthusiast. Blogger at http://www.LiveFreeMD.com

    #244828 Reply
    Liked by Larry Ragman
    Zaphod Zaphod 
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    You’re terribly young to be 50:50. Your return on bonds is simply going to be the yield over the duration and nothing more. All that means is you’ll have to save more.

    I agree that people over estimate their risk tolerance, but a different issue is going to far in the conservative direction. They are both risks of different kinds. Too much bonds too young is longevity risk, that you’ll either not have enough or outlive your money.

    Now, you’ll probably be fine as a doctor but something to think about. Maybe you could have some kind of automatic rebalancer, say you hear we are in a recession, etc…maybe increase to 75/25 and hold for many years and slowly back off to your 50/50.

    You cant take any recomendation from an active investor the 1950s seriously, similarly the reason hedge funds crushed it in the 80s, bonds gave a ton of return and made things much easier, that is not the case today.

    #245013 Reply
    Liked by ZZZ
    Avatar Tim 
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    OP,
    Kudos to you on the methodology you are using choosing your AA. You are 100% correct in analyzing your risk profile. It is a combination of risk tolerance and risk capacity. The purpose is simply to take the emotional behaviors out of AA choices so one can stay the course and not change course with the peaks and valleys.
    Volatility is different. It includes BOTH the ups and downs. Prudent as it may seem, recency bias and a fear of loss are emotional factors, the types of things one is attempting to eliminate in choosing an AA.
    Your earnings are your insurance that you have the capacity to stick to your AA from an investment perspective. Statistics show that over a 30-50 year period, returns will be better with a higher equity component. I would suggest you rethink the analytics you are using. Seems like the volatility and fear of a temporary decline is greatly impacting your AA choice for the wrong reasons.
    The right reason would be “no need to seek higher returns “. The wrong reason is fear of volatility.

    AA is the primary decision, get that right and you are left with optimizing taxes. IRA’s and 401k’s and muni’s and bond fund selections are tax strategies.
    Look at the historical returns of 60/40, 50/50, 70/30 rather than specific 5 or 10 year periods. Those periods are included in the historical results. Cherry picking will not serve you well. Choose your AA without emotion as much as possible. As the investments grow, it’s about the pluses and minuses combined. Small tweak in your reasoning may lead to a different choice.
    Maybe not!

    #245021 Reply
    Liked by BladeRunner

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