SEC Official Warns of Risks In Muni Bond Market

[Ad Orientem]

http://video.cnbc.com/gallery/?video=3000162410

It's worth repeating that munis are not appropriate for the PP. And I will take that a step further and opine that unless you are a HNWI with a ton of money in taxable accounts, munis just really don't make sense for most investors even outside the PP. The tax advantages are frequently overrated. Even people with a lot of money often have half or more of it in tax deferred/sheltered accounts.

[dualstow]

http://video.cnbc.com/gallery/?video=3000162410

It's worth repeating that munis are not appropriate for the PP. And I will take that a step further and opine that unless you are a HNWI with a ton of money in taxable accounts, munis just really don't make sense for most investors even outside the PP. The tax advantages are frequently overrated. Even people with a lot of money often have half or more of it in tax deferred/sheltered accounts.

I have several friends, relatives and acquaintances with more than half in munis. Some have *all* in munis. I have suggested alternatives like bogleheadish 60/40 (stocks/bonds), lazy portfolios and the pp, mostly to no avail. They like their income and they're not interested. I suspect that only after a disaster, i.ie. after it's too late, would they express interest in something else.

I've got a little over 3% of my pp+vp in a Vanguard muni bond fund. It's money I'm willing to lose.

[Pointedstick]

Step right up, folks. Just look at those yields! 

[Ad Orientem]

Okay, there is no question munis carry default risks that treasuries do not. However, if you have a lot of taxable accounts, and are in a high tax bracket, and you are willing to assume a little more risk in exchange for higher yield, I think a slug of munis in a VP is reasonable. Certainly, you should opt for a less risky fund and if practical, an insured one.

Two quick observations. First I don't hate munis. I just think they are incompatible with a PP. That said, for people who have the misfortune of being very wealthy and stuck with all or most of their money in taxable accounts, and who can handle some added volatility, a boglehead type portfolio with a well run low cost muni fund comprising the bond portion might be a good choice for an investment vehicle.

If I won the mega power super lottery thingy and walked away with nine figures after taxes I'd have take into consideration that a 40% tax on LTT yields will act in much the same way as high ER does in actively managed funds. It will severely detract from long term returns. So yes, for high net worth individuals who have lots of money in unsheltered accounts I could see an argument for munis.  Living in the Soviet Socialist Republic of California I could see 55% VCADX - 30% VT - 15% Gold.

But they don't work in a PP

As for a VP play, I suppose that depends on what you think the VP is for. I have always seen the VP as where you try to beat the market. How you do that with muni bonds is a bit fuzzy to me.

[sophie]

Munis might be reasonable if you're one of highest taxed people in your high-tax state, or as part of an income-producing strategy in retirement.  But I don't think it stacks up to a taxable PP, because the PP is so tax-efficient to begin with.

Let's take NY as an example.  VNYTX's (long term muni) dividend yield for the past year was 3.39%, ignoring capital gains/losses.  Let's say the PP returned 5% over the same period.  Assuming tax rates of 25% on capital gains (15% federal, 10% state/local) plus taxes on interest income, your PP would net 3.72%.  Score:  PP 1, Muni fund 0.

I can see where a muni fund is tempting, but it doesn't really make sense for someone in the accumulation phase.  I had one up to a year ago, and got rid of it after I did a few of the above calculations.  More risk for less reward, anyone?

[Ad Orientem]

Munis might be reasonable if you're one of highest taxed people in your high-tax state, or as part of an income-producing strategy in retirement.  But I don't think it stacks up to a taxable PP, because the PP is so tax-efficient to begin with.

Let's take NY as an example.  VNYTX's (long term muni) dividend yield for the past year was 3.39%, ignoring capital gains/losses.  Let's say the PP returned 5% over the same period.  Assuming tax rates of 25% on capital gains (15% federal, 10% state/local) plus taxes on interest income, your PP would net 3.72%.  Score:  PP 1, Muni fund 0.

I can see where a muni fund is tempting, but it doesn't really make sense for someone in the accumulation phase.  I had one up to a year ago, and got rid of it after I did a few of the above calculations.  More risk for less reward, anyone?

I agree with your general point, but in fairness I am sort of assuming that a muni fund would not be a stand alone portfolio. If they used the portfolio I described 55% VCADX 30% VT 15% Gold in 2012 we had a gross pretax return of 12.6% (rounding to the nearest tenth) including dividends and excluding ER. From which we would subtract a combined state and Federal tax of 25% on the dividends from VT (.6%) which drops us down to 12%. From which we would subtract an ER of no more than .2% (I am getting lazy here) and that brings us down to 11.8% give or take a couple tenths of a percentage. That's not a bad return.

This is of course assuming there was no rebalancing, which I doubt there would be given the numbers.

I think your point is mostly correct. The PP is generally a very tax efficient portfolio construct. But for people who really are uber wealthy and who also have most of their money in taxable accounts, I could see the attraction to munis, provided they can endure a bit more volatility.