does a bond fund make sense?

[hegemony]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

Edited February 2, 2010 by hegemony

[Kevin20]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

So, background, a "tax exempt" bond fund like VWITX basically means a municipal bond fund, investing in state and local bonds. "Tax exempt" doesn't mean totally tax exempt -- It's exempt from FEDERAL taxes, because years ago the Supreme Court ruled that the federal government cannot tax a state's interest payments, and vice versa, IIRC. But one state can tax another state's interest -- so you'd probably face state income taxes if you live in an income-tax state (states usually or always exempt their own issues from their state taxes though).

 

Anyway, because they are (mostly) tax-exempt and are relatively safe, the underlying bonds generally pay out low interest rates, comparable to the after-tax interest on an taxable investment grade bond. Now that's a nice thing for rich people in the 35% tax bracket who don;t need to grow their capital ... the tax exempt bond interest gives them sufficient income with little taxes due on it, and not much risk to capital. I recall reading once that H. Ross Perot was invested mostly in municipal bonds. So that's why the prospectus said that about income.

 

But the problem is you can't expect much growth. The underlying bonds would go up in value if interest rates fell, which would make the mutual fund shares go up, but that tends to be temporary, since interest rates don't fall forever. And when interest rates turn and increase, the underlying bonds lose value.

 

So you got a 3 or 4% yield from interest payments, against the backdrop of the underlying bond prices rising or falling with interest rate cycles. Net result is you're probably looking at long-run average returns on the mutual fund of 3 - 4% (including the yield). So in other words you basically get the yield income but very little capital appreciation over time.

 

Sure enough, if you look at the stock chart for VWITX, the fund price has been hovering around $12 - $13.50 since the Reagan Administration.

http://bit.ly/9xh17H

 

....which, BTW, means the fund price lost out quite a bit to inflation. Including the yield payouts, probably a VWITX investor over the last 20 years only managed to keep up with inflation, and nothing more. Somewhat better over the last decade though, as interest rates have fallen almost the whole time (boosting bond prices).

 

So if you're looking at a long term retirement investment, you'd presumably want to accept some more risk to get a lot of capital appreciation over time - a stable but modest yield over 20 - 30 years won't get the job done.

Edited February 3, 2010 by Kevin20

[VK]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

So, background, a "tax exempt" bond fund like VWITX basically means a municipal bond fund, investing in state and local bonds. "Tax exempt" doesn't mean totally tax exempt -- It's exempt from FEDERAL taxes, because years ago the Supreme Court ruled that the federal government cannot tax a state's interest payments, and vice versa, IIRC. But one state can tax another state's interest -- so you'd probably face state income taxes if you live in an income-tax state (states usually or always exempt their own issues from their state taxes though).

 

Anyway, because they are (mostly) tax-exempt and are relatively safe, the underlying bonds generally pay out low interest rates, comparable to the after-tax interest on an taxable investment grade bond. Now that's a nice thing for rich people in the 35% tax bracket who don;t need to grow their capital ... the tax exempt bond interest gives them sufficient income with little taxes due on it, and not much risk to capital. I recall reading once that H. Ross Perot was invested mostly in municipal bonds. So that's why the prospectus said that about income.

 

But the problem is you can't expect much growth. The underlying bonds would go up in value if interest rates fell, which would make the mutual fund shares go up, but that tends to be temporary, since interest rates don't fall forever. And when interest rates turn and increase, the underlying bonds lose value.

 

So you got a 3 or 4% yield from interest payments, against the backdrop of the underlying bond prices rising or falling with interest rate cycles. Net result is you're probably looking at long-run average returns on the mutual fund of 3 - 4% (including the yield). So in other words you basically get the yield income but very little capital appreciation over time.

 

Sure enough, if you look at the stock chart for VWITX, the fund price has been hovering around $12 - $13.50 since the Reagan Administration.

http://bit.ly/9xh17H

 

....which, BTW, means the fund price lost out quite a bit to inflation. Including the yield payouts, probably a VWITX investor over the last 20 years only managed to keep up with inflation, and nothing more. Somewhat better over the last decade though, as interest rates have fallen almost the whole time (boosting bond prices).

 

So if you're looking at a long term retirement investment, you'd presumably want to accept some more risk to get a lot of capital appreciation over time - a stable but modest yield over 20 - 30 years won't get the job done.

 

kevin20, very nice answer....you obviously know what you are talking about...

 

If I may - what do you think about a fund like Pimco Total Return? good play for 2010? It did great in 2009, but interest rates bound to go up in 2010, and with that the price of bonds will go down........ Also, a strategy mix of keeping income producing investments concentrated in tax deferred accounts, like IRA, and stocks in investment portfolio - the idea being that you hold taxable bonds in IRA or roth, and stocks as investment to generate capital gains/loss that are taxed at lower rate than income from bonds?

 

Thanks,

 

VK

[bullthistle]

Since I am closing in on retirement I am looking for dividends in my tax exempt accounts. Look into www.closed-endfunds.com. I look for yield and have dividend re-investment. I wouldn't jump now because most funds have had a run since March '09 but I would keep an eye on them during pull backs. IGD, ETW, ETY, EXG recently lowered their dividends and so are either at NAV or below. Many do not subscribe getting into funds that sell at a premium like AOD, however I've sold funds in the past year when I have been up over 35% and scrunge around for others. Might also look at JNK, AGNC, RSO, ANH, NLY, but when they raise rates they could drop drastically so you must be ready to pull the trigger. I use quote tracker to follow my holdings, but you can write the costs off on taxes.

[VK]

Since I am closing in on retirement I am looking for dividends in my tax exempt accounts. Look into www.closed-endfunds.com. I look for yield and have dividend re-investment. I wouldn't jump now because most funds have had a run since March '09 but I would keep an eye on them during pull backs. IGD, ETW, ETY, EXG recently lowered their dividends and so are either at NAV or below. Many do not subscribe getting into funds that sell at a premium like AOD, however I've sold funds in the past year when I have been up over 35% and scrunge around for others. Might also look at JNK, AGNC, RSO, ANH, NLY, but when they raise rates they could drop drastically so you must be ready to pull the trigger. I use quote tracker to follow my holdings, but you can write the costs off on taxes.

 

 

Very interesting, thanks!

 

first time I hear about CEF - interesting read.....I am relatively young, and so don't spent much time managing my 401k and IRA, and don't have much of the investments outside of tax exempt accounts...closed-endfunds.com is very interesting, I will make sure to read more on CEFs....thanks for reference. Why do you prefer CEFs over, say, bond mutual funds, like Pimco Total Return? Quote tracker - is that free lookup in yahoo finance, or something?

 

thanks for the info, much appreciated,

 

VK

[TroyP]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

So, background, a "tax exempt" bond fund like VWITX basically means a municipal bond fund, investing in state and local bonds. "Tax exempt" doesn't mean totally tax exempt -- It's exempt from FEDERAL taxes, because years ago the Supreme Court ruled that the federal government cannot tax a state's interest payments, and vice versa, IIRC. But one state can tax another state's interest -- so you'd probably face state income taxes if you live in an income-tax state (states usually or always exempt their own issues from their state taxes though).

 

Anyway, because they are (mostly) tax-exempt and are relatively safe, the underlying bonds generally pay out low interest rates, comparable to the after-tax interest on an taxable investment grade bond. Now that's a nice thing for rich people in the 35% tax bracket who don;t need to grow their capital ... the tax exempt bond interest gives them sufficient income with little taxes due on it, and not much risk to capital. I recall reading once that H. Ross Perot was invested mostly in municipal bonds. So that's why the prospectus said that about income.

 

But the problem is you can't expect much growth. The underlying bonds would go up in value if interest rates fell, which would make the mutual fund shares go up, but that tends to be temporary, since interest rates don't fall forever. And when interest rates turn and increase, the underlying bonds lose value.

 

So you got a 3 or 4% yield from interest payments, against the backdrop of the underlying bond prices rising or falling with interest rate cycles. Net result is you're probably looking at long-run average returns on the mutual fund of 3 - 4% (including the yield). So in other words you basically get the yield income but very little capital appreciation over time.

 

Sure enough, if you look at the stock chart for VWITX, the fund price has been hovering around $12 - $13.50 since the Reagan Administration.

http://bit.ly/9xh17H

 

....which, BTW, means the fund price lost out quite a bit to inflation. Including the yield payouts, probably a VWITX investor over the last 20 years only managed to keep up with inflation, and nothing more. Somewhat better over the last decade though, as interest rates have fallen almost the whole time (boosting bond prices).

 

So if you're looking at a long term retirement investment, you'd presumably want to accept some more risk to get a lot of capital appreciation over time - a stable but modest yield over 20 - 30 years won't get the job done.

 

kevin20, very nice answer....you obviously know what you are talking about...

 

If I may - what do you think about a fund like Pimco Total Return? good play for 2010? It did great in 2009, but interest rates bound to go up in 2010, and with that the price of bonds will go down........ Also, a strategy mix of keeping income producing investments concentrated in tax deferred accounts, like IRA, and stocks in investment portfolio - the idea being that you hold taxable bonds in IRA or roth, and stocks as investment to generate capital gains/loss that are taxed at lower rate than income from bonds?

 

Thanks,

 

VK

 

This question is a bit hard to follow... but I think I understand where you're going.

 

To achieve the greatest tax efficiency, you would direct your income funds (those that pay either interest or non-qualified dividends) into your tax advantaged funds. If you had remaining room, you would then go for growth funds, and you would really only hold munis in a tax advantaged account if you had a compelling reason to do so.

 

The reason for this, is because of the varying tax implications of the investments:

 

Income funds which produce either taxable interest or non-qualified dividend income are taxed at your marginal tax rate. So we get the most advantage from the tax benefit by tucking them away in the tax advantaged account.

 

Growth funds produce capital gain income, which is generally taxed at a reduced rate (currently 15%, but probably heading to 20% at some point soon). Since the effective tax rate on these investments is a bit lower, the tax benefit of keeping them in a tax advantaged fund is smaller.

 

Finally, Muni bonds, and other investments exempt from taxation generally realize little benefit from being in a tax advantaged account (since the securities themselves are tax advantaged), so its wiser to keep them out of the tax advantaged accounts if you can contribute more than the maximum amount to your tax advantaged accounts.

 

Lets assume you have $30,000 to invest, and to make the numbers easy, we'll say the maximum 401(k) contribution is $15,000, your 401(k) is the only tax deferred account you are eligible for, and that you would like your assets split equally between income, growth, and Municipal bonds. To the extent that you have good funds in your 401(k) (and they vary substantially between plans and custodians, so you may or may not) you would allocate $10,000 to your income funds in the 401(k), split the growth funds between the remaining $5,000 in room you have in your 401(k) and put the other $5,000 into a taxable account with all the muni bonds.

[bullthistle]

Unfortunately Ameritrade bought Medved Quote Tracker and beleive it is $60 a year but you can get it for free if you don't mind the ads. I stay away from mutual funds because you can only purchase at the end of the day and not all are free. Fidelity now has $7.95 trades, started today, for all tiers. CEF's pay monthly, quarterly and semi-annually. I prefer monthly however. Doesn't matter how long you have to retirement staring early, which I did not do, it takes a while to catch up. I just bought RSO today but I'll have to watch interest rates. Any dividend over 10% is worth a shot and just have the dividends re-invested. Just be careful. Do not purchase if NAV is way below closing price like PHK. Doubling one's money in six years or less can be awesome especially if you have decades before you retire.

[Operation_Home_Ownership]

Awww nice to see Hege & Stinker starting off 20-10 right. Touched, and great answer!

[athensgaguy]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

In a regular brokerage account, a tax free bond is more or less a slightly riskier but slightly higher yield version of a savings account except you'll only pay state income taxes on the dividends (unless you get an NV only fund).

 

I've decided to start dropping a little money here and there into a muni-fund (SWNTX in my case, I'm only putting a little in there and it has low mins). If you want to put more, TWTIX looks good, too.

 

Muni funds don't make much sense in a tax advantaged account. You would want a higher yield fund like PIMCO's total return or Manager's PIMCO Fund (MBDFX). It also depends on which ones you can buy without a load. In my Fidelity 457 I don't pay a load on things, and TPINX is a really nice fund.

[hegemony]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

In a regular brokerage account, a tax free bond is more or less a slightly riskier but slightly higher yield version of a savings account except you'll only pay state income taxes on the dividends (unless you get an NV only fund).

 

I've decided to start dropping a little money here and there into a muni-fund (SWNTX in my case, I'm only putting a little in there and it has low mins). If you want to put more, TWTIX looks good, too.

 

Muni funds don't make much sense in a tax advantaged account. You would want a higher yield fund like PIMCO's total return or Manager's PIMCO Fund (MBDFX). It also depends on which ones you can buy without a load. In my Fidelity 457 I don't pay a load on things, and TPINX is a really nice fund.

 

no state income tax in NV.

 

this fund would be held outside a tax-advantaged account.

 

Kevin, thanks for your very detailed and thoughtful answer. The fund price has been flat but then how can the prospectus claim a "return"

 

5% tax free is fine with me as we are in the 35% marginal tax bracket.

[athensgaguy]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

In a regular brokerage account, a tax free bond is more or less a slightly riskier but slightly higher yield version of a savings account except you'll only pay state income taxes on the dividends (unless you get an NV only fund).

 

I've decided to start dropping a little money here and there into a muni-fund (SWNTX in my case, I'm only putting a little in there and it has low mins). If you want to put more, TWTIX looks good, too.

 

Muni funds don't make much sense in a tax advantaged account. You would want a higher yield fund like PIMCO's total return or Manager's PIMCO Fund (MBDFX). It also depends on which ones you can buy without a load. In my Fidelity 457 I don't pay a load on things, and TPINX is a really nice fund.

 

no state income tax in NV.

 

this fund would be held outside a tax-advantaged account.

 

Kevin, thanks for your very detailed and thoughtful answer. The fund price has been flat but then how can the prospectus claim a "return"

 

5% tax free is fine with me as we are in the 35% marginal tax bracket.

 

The yield is the dividends paid.

[Kevin20]

we're looking for gains that are mostly free from tax. but the prospectus says these funds are for people who want to generate income. that is not us since we have decades before we retire.

 

is a bond fund like VWITX sensible for us? I mostly think yes, but after reading the prospectus I am unsure.

 

In a regular brokerage account, a tax free bond is more or less a slightly riskier but slightly higher yield version of a savings account except you'll only pay state income taxes on the dividends (unless you get an NV only fund).

 

I've decided to start dropping a little money here and there into a muni-fund (SWNTX in my case, I'm only putting a little in there and it has low mins). If you want to put more, TWTIX looks good, too.

 

Muni funds don't make much sense in a tax advantaged account. You would want a higher yield fund like PIMCO's total return or Manager's PIMCO Fund (MBDFX). It also depends on which ones you can buy without a load. In my Fidelity 457 I don't pay a load on things, and TPINX is a really nice fund.

 

no state income tax in NV.

 

this fund would be held outside a tax-advantaged account.

 

Kevin, thanks for your very detailed and thoughtful answer. The fund price has been flat but then how can the prospectus claim a "return"

 

5% tax free is fine with me as we are in the 35% marginal tax bracket.

 

The yield is the dividends paid.

 

 

Yes there is a positive return based on the interest paid by the underlying bonds ... which in the mutual fund, translates into dividends in the form of more mutual fund shares being created and credited to the mutual fund investors. (Though you can usually select the option of being paid in cash instead of shares when you invest in the mutual fund, if I recall how that works).

 

With mutual funds people think in terms of how much money they invest, not how many shares they buy. But, if at the start you had bought 1000 shares of a mutual fund, then maybe a couple years later you realize you have 1100 shares, without you having added any more money. You received those additional shares as a dividend. If the fund share price is the same, you have still enjoyed a return.

Edited February 4, 2010 by Kevin20

[Kevin20]

If I may - what do you think about a fund like Pimco Total Return? good play for 2010? It did great in 2009, but interest rates bound to go up in 2010, and with that the price of bonds will go down........ Also, a strategy mix of keeping income producing investments concentrated in tax deferred accounts, like IRA, and stocks in investment portfolio - the idea being that you hold taxable bonds in IRA or roth, and stocks as investment to generate capital gains/loss that are taxed at lower rate than income from bonds?

 

Thanks,

 

VK

 

TroyP handles the tax issue above ... bottom line, it can be worthwhile to put something taxed as ordinary income (like bond interest) into a tax deferred account. I also like the idea of putting a REIT or REIT fund/ETF into an IRA, because they can pay relatively high dividends, but the taxation is confusing (not taxed as qualified dividends because most of the corporate profit must be passed through to the shareholders), so I'd prefer to avoid dealing with those taxes.

 

Now that said, I wouldn't want to stuff my IRA with nothing but bond funds. You MIGHT get lucky in your lifetime stock investing and accumulate a lot of money ... a 15% annual return over a couple of decades would work miracles. It would be nice to have that accumulate unfettered of taxes in a tax-deferred account, which also gives you the freedom to revise your portfolio by selling old stuff and buying new stuff and rebalancing, without that being a taxable event every time.

 

As for bond funds in 2010, well Bill Gross of PIMCO is the world's most famous bond investor -- he'll probably do allright. I don't pretend to predict interest rates myself, but there is an argument that they are so low now, they'll likely go up and that would be difficult on bond funds. Some pundits are worried that retail investors are pouring money into bond funds at a record pace, even as bond funds are possibly at their peak -- because people got burned in stocks, they are perhaps unwisely jumping into the alternative -- bonds -- just in time to get burned again.

 

I think there is some possibility of that ... personally I reallocated the bond portion of my 401k to have a smaller slice for now.

Edited February 4, 2010 by Kevin20

[bullthistle]

Today might be a good day to start investing unless someone beleives the market is going lower. I started investing in mutual funds but they can guess the direction of the market better than the individual can? Besides mutual funds have a minimum that a person can invest and usually the better funds are only open to institutions so I figured why pay someone to lose my money versus myself. It takes time to learn and I visit Yahoo message boards to get leads to broaden my horizon because there are smart people at those boards just as there are shills.

[athensgaguy]

Today might be a good day to start investing unless someone beleives the market is going lower. I started investing in mutual funds but they can guess the direction of the market better than the individual can? Besides mutual funds have a minimum that a person can invest and usually the better funds are only open to institutions so I figured why pay someone to lose my money versus myself. It takes time to learn and I visit Yahoo message boards to get leads to broaden my horizon because there are smart people at those boards just as there are shills.

 

Many funds can be purchased without a transaction fee. If you're investing small amounts, then transaction fees can eat you up.

 

Also, today is a day that I wish I owned 100% bond funds.

[Kevin20]

Today might be a good day to start investing unless someone beleives the market is going lower. I started investing in mutual funds but they can guess the direction of the market better than the individual can? Besides mutual funds have a minimum that a person can invest and usually the better funds are only open to institutions so I figured why pay someone to lose my money versus myself. It takes time to learn and I visit Yahoo message boards to get leads to broaden my horizon because there are smart people at those boards just as there are shills.

 

 

I'm a lot more interested in ETF's these days than mutual funds -- they let you tailor a portfolio just how you want it, pretty cheap.