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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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    Status: Physician
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    Thank you all for the thoughts on my asset allocation.  I plan to stay 50:50 through the next recession.  At that point, if I feel it was too conservative, then I’ll increase it to 60:40.  Getting back to the original question, assuming that I have a large monetary amount of bonds in my taxable account, is there a significant risk with having this entirely in an intermediate term municipal bond fund?

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

    #245475 Reply
    Avatar Larry Ragman 
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    Joined: 08/30/2018

    Short answer: no, you’re fine with an intermediate term muni index fund given your preferred AA.

    Slightly longer answer: you face a risk that interest rates will go up over your investment period, which would reduce the value of the bonds in your fund. This of course would be compensated by the fund acquiring higher interest rate bonds, so in the long term there is more or less a wash. This is mitigated if you want the dividends and don’t mind the fund actually accruing a small capital loss. If you actually held individual muni bonds you would not have to be concerned about this at all assuming you held the bonds to maturity, but the risk of default on any specific bond is much higher than an index fund of bonds. You are probably close to the point that an individual muni bond ladder over 5-7 years might be better, but I’d stick to the index fund. Too much trouble to pick the bonds.

    By the way, interest rates will go up, but who knows when. They’ve been dropping since 1982 (money market funds peaked at something like 18%). It has been a great bull run in bonds.

    #245476 Reply
    Avatar ZZZ 
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    Do you know what duration is?

    #245488 Reply
    Avatar Tim 
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    Earnest refinancing bonus

    “ I plan to stay 50:50 through the next recession. At that point,”

    Don’t we all wish we could master this plan. I am not criticizing the plan. The difficulty is the feasibility.
    Beginning, length and end are all unknowns and actually identified six months to a year after the fact. And then, the beginning, length and end of the recovery need to be considered. Economic cycles happen, but are known only after the fact with the same uncertainty in the next cycle.

    Statistically speaking, your AA is a coin toss, 50:50.
    The S&P is up 3.9% in 12 months. Seems a little low compared to the average returns while bonds have done great. Meanwhile the economy seems to be slow and steady.

    I think you parked at 50:50 out of fear of loss, not based on a plan based on tracking recession and recovery cycles. Nothing wrong with that at all.

    #245511 Reply
    Avatar Peds 
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    Status: Physician
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    Joined: 01/08/2016
    is there a significant risk with having this entirely in an intermediate term municipal bond fund?

    Click to expand…

    i would not lose sleep over it.

    #245533 Reply
    Avatar StarTrekDoc 
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    Status: Physician
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    Joined: 01/15/2017

    Nope.  with 50:50  balance ;   TE Intermediate fits right into that strategy —  sleep well.  Stomp out disease.

    #245556 Reply
    Live Free MD Live Free MD 
    Participant
    Status: Physician
    Posts: 92
    Joined: 01/03/2017

    Short answer: no, you’re fine with an intermediate term muni index fund given your preferred AA.

    Slightly longer answer: you face a risk that interest rates will go up over your investment period, which would reduce the value of the bonds in your fund. This of course would be compensated by the fund acquiring higher interest rate bonds, so in the long term there is more or less a wash. This is mitigated if you want the dividends and don’t mind the fund actually accruing a small capital loss. If you actually held individual muni bonds you would not have to be concerned about this at all assuming you held the bonds to maturity, but the risk of default on any specific bond is much higher than an index fund of bonds. You are probably close to the point that an individual muni bond ladder over 5-7 years might be better, but I’d stick to the index fund. Too much trouble to pick the bonds.

    By the way, interest rates will go up, but who knows when. They’ve been dropping since 1982 (money market funds peaked at something like 18%). It has been a great bull run in bonds.

    Click to expand…

    Thank you.  As I understand, the interest rate risk applies to all bond funds, not just municipal bond funds.  I am comfortable with the interest rate risk.  I just want to make sure that I am not unknowingly exposing myself to excessive risk by owning a large volume of municipal bonds in my taxable account.

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

    #245864 Reply
    Live Free MD Live Free MD 
    Participant
    Status: Physician
    Posts: 92
    Joined: 01/03/2017

    Do you know what duration is?

    Click to expand…

    If I understand correctly, the duration of a bond fund indicates how sensitive the price of the bond is to changes in interest rate.  The Vanguard Intermediate Tax exempt fund has a duration of 5 years.  Therefore, if interest rates rise by 1%, then the price of the bond will fall by 5%.

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

    #245865 Reply
    Avatar afan 
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    Joined: 05/07/2017

    Considering only federal taxes munis provide a better after tax return than treasuries if your income is high enough. This is the argument for munis in taxable for certain investors. But the difference is not huge right now. Neither pay very much, so you are saving a fraction of a small difference.

    If you pay a state income tax, particularly a high one, then treasuries have the advantage of being state tax free. This narrows the difference between munis and treasuries. If you pay a state income tax then your general national tax free fund will be mostly taxable for state income tax. You could go with a single state muni fund but that over exposes you to the credit risk of your state.

    Some people are concerned that municipalities have huge unfunded liabilities, especially pensions. That plus the thin market makes people worry that trading could freeze up in a downturn. And that individual munis could plummet in value or even default.

    If you are so risk averse that you want to be 50% in bonds then you might be more comfortable with at least some of your bonds in treasuries or FDIC insured CDs.

    #245907 Reply

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