Gyroscopic Investing

Hello all.

My father is potentially interested in getting into a Target Date Fund from Fidelity such as "Fidelity Municipal Income 2021 Fund" (FOCFX). Essentially they purchase a ladder of Municipal Bonds with maturities ranging from now till June of 2021 when they liquidate the fund. From the prospectus, the bond fund doesn't say anything about owning callable bonds (not positive however).

They have an expense ratio of .4% and as far as I know reasonably low turnover ratios. As the maturity date gets near, they purchase money market funds instead. I'm not also fully positive on the tax implications of muni bonds in general other than not paying federal tax on them.

I was wondering if anyone had any experience with funds such as this, or municipal bonds in general for being in a tax rate of around 28%.

Feel free to poke any holes in why you'd want to own/not own municipal bonds. He's in his late 50s as of now and is looking at getting more into bonds to preserve his wealth as he will be entering retirement in the next 10 years or so.

Thanks for any input. I appreciate it.

Well it's not a PP so I think you know what kind of answers you'll receive. I would honestly just recommend a PP. Muni bonds are riskier than treasury bonds, and FOCFX doesn't looks like it's been around for very long either, so that's another red flag. Google's crude tools show that during FOCFX's brief existence, my PPs would have outperformed it by more than 3% with a similar or lower level of volatility:

Pointedstick wrote: Well it's not a PP so I think you know what kind of answers you'll receive. I would honestly just recommend a PP. Muni bonds are riskier than treasury bonds, and FOCFX doesn't looks like it's been around for very long either, so that's another red flag. Google's crude tools show that during FOCFX's brief existence, my PPs would have outperformed it by more than 3% with a similar or lower level of volatility:

Haha to the answers I'd receive response. I'd agree with you on that although I haven't gotten him into the PP yet. I'm just trying to see if there is anything I'm missing regarding muni bonds or if I can give a good argument to him for why you would or wouldn't want to have muni bonds as a consistent source of federally non-taxable income. He's as of the moment trying to get more bonds and less of stocks as he's been getting older. So the whole getting a more conservative porfolio as you get older.

If you haven't convinced him of the PP yet, how's this for a simple, incredibly conservative portfolio that does better than FOCFX and results in an easy transition to a PP later: 15% stocks, 15% gold, 70% 1-3 year treasuries. 8.58% CAGR with the worst year dropping less than 1%:

http://www.riskcog.com/portfolio-theme2.jsp#5490498jwe

the Boglehead 50% stock 50% US bond index (index that BND tracks) is a good asset alloc (AA), somewhat similar to Perm Port in terms of low drawdown & return >= CPI inflation.

My guesstimate is that substituting a set of US Treasuries (USTs) for the bonds would work as well or better than the BND index.

either
25% 0-3 yr USTs, 25% 30 yr USTs (this obviously would be good for allowing easy switch over to a Perm Port)
or
50% 30 yr USTs

It seems that it is difficult for many of us humans to fully understand & believe in the idea of look at an AA as a package, not individual assets.  I know I hadn't before learning about & adopting the Perm Port AA.

My guesstimate sense is that, the higher the percent of one's Investable Pie's is in tax-adv (401k/IRA/etc) accounts, the less relevant the usefulness of the tax advantages of muni bonds would be.

cabronjames wrote: the Boglehead 50% stock 50% US bond index (index that BND tracks) is a good asset alloc (AA), somewhat similar to Perm Port in terms of low drawdown & return >= CPI inflation.

My guesstimate is that substituting a set of US Treasuries (USTs) for the bonds would work as well or better than the BND index.

either
25% 0-3 yr USTs, 25% 30 yr USTs (this obviously would be good for allowing easy switch over to a Perm Port)
or
50% 30 yr USTs

It seems that it is difficult for many of us humans to fully understand & believe in the idea of look at an AA as a package, not individual assets.  I know I hadn't before learning about & adopting the Perm Port AA.

My guesstimate sense is that, the higher the percent of one's Investable Pie's is in tax-adv (401k/IRA/etc) accounts, the less relevant the usefulness of the tax advantages of muni bonds would be.

Thanks for the reply cabronjames.

As of now, I believe a reasonably large amount is in tax advantaged accounts. He had a corporate bond mature and has been looking towards finding another steady source of income and over time I believe he is thinking of getting more into bonds. I'll see if I can get him into the Permanent Portfolio but in the mean-time, I'm trying to give him ideas for asset allocations. He brought that muni bond target date fund prospectus to me that he got from a financial adviser and was asking what I thought of it.

I'm still quite young in the investment world so I thought I'd ask the collective ultimate wisdom that is this forum to see if you people could give him compelling reasons as to why, or possibly more importantly, why you wouldn't want muni bonds for your asset allocation. As I said he's in his late 50's and I believe in the 28% tax bracket and is already reasonably in stocks and wants to grow his bond portion and he thought muni bonds might be the way to go for him.

Again thanks for all the input on this stuff. I appreciate it a lot.

http://www.bogleheads.org/wiki/Vanguard_Fund_Info

fyi - looks like Vanguard has some muni bond funds, with lower expense ratios.  for example "long term tax-exempt" VWLTX is 0.20%er, 0.12% for AdmiralShares version (altho high $50K min).  Not sure if Vanguard offers something that is as long duration as  FOCFX.

Many of us Forumers here save on investing costs on the 30 yr bond asset by buying individual bonds.  I wonder if this would be relevant in muni bonds, if one intended to hold for 5 or 10+ years?  Surely the commission & bid-ask spread could be worse with munis than USTs, USTs are very liquid/high volume.

cabronjames wrote: http://www.bogleheads.org/wiki/Vanguard_Fund_Info

fyi - looks like Vanguard has some muni bond funds, with lower expense ratios.  for example "long term tax-exempt" VWLTX is 0.20%er, 0.12% for AdmiralShares version (altho high $50K min).  Not sure if Vanguard offers something that is as long duration as  FOCFX.

Many of us Forumers here save on investing costs on the 30 yr bond asset by buying individual bonds.  I wonder if this would be relevant in muni bonds, if one intended to hold for 5 or 10+ years?  Surely the commission & bid-ask spread could be worse with munis than USTs, USTs are very liquid/high volume.

I've looked into individual bonds for munis. Fidelity offers them for $1/per bond sold so if you bought $10000 in bonds, it looks like it would be a $10 trading cost. This isn't actually too bad and you could create your own target date fund of municipal bonds. I guess the question more is how do you determine which muni bonds are more worthwhile than others. Unlike treasury bonds, there are a large amount of choices within munis and that can lead to analysis paralysis when picking which munis would be good for you or not.

1NV35T0R wrote:

cabronjames wrote:
...Many of us Forumers here save on investing costs on the 30 yr bond asset by buying individual bonds.  I wonder if this would be relevant in muni bonds, if one intended to hold for 5 or 10+ years?  Surely the commission & bid-ask spread could be worse with munis than USTs, USTs are very liquid/high volume.

I've looked into individual bonds for munis. Fidelity offers them for $1/per bond sold so if you bought $10000 in bonds, it looks like it would be a $10 trading cost. This isn't actually too bad and you could create your own target date fund of municipal bonds. I guess the question more is how do you determine which muni bonds are more worthwhile than others. Unlike treasury bonds, there are a large amount of choices within munis and that can lead to analysis paralysis when picking which munis would be good for you or not.

interesting point.

I suppose you could look at a muni index fund's top holdings by percent of fund, & pick a mix of 5 of those or some such.  But I'm just guesstimating.

I don't really share the usual prejudices against Munis. Historically they have been very safe as long as you don't put all of your money in a single bond issue or issuer. My main hangup with Munis is that they really aren't very attractive unless you are in the top income tax bracket. Unless your wealthy Munis make no sense. But yea if you have combined assets deep in the eight figures (or more) and you can handle the increased volatility I would surmise that a very low cost intermediate term Muni fund would yield better returns over the long term because of the tax savings. So yea if I had a cool hundred million I might well go 50% VCADX 30% VTI and 20% Gold. The volatility would be a tad higher but long term I am guessing I'd come out ahead because I would be avoiding a 35% tax bite on half of my portfolio. And (yes I am prognosticating here) I seriously believe that taxes will eventually be going up. There is no way we can realistically get our debt under control through spending cuts alone.  But all of this is predicated on being wealthy and able to handle higher volatility.

On a side note I have absolutely no idea why anyone would speculate in Muni bonds for a VP but to each their own.

Ad Orientem wrote: I don't really share the usual prejudices against Munis. Historically they have been very safe as long as you don't put all of your money in a single bond issue or issuer. My main hangup with Munis is that they really aren't very attractive unless you are in the top income tax bracket. Unless your wealthy Munis make no sense. But yea if you have combined assets deep in the eight figures (or more) and you can handle the increased volatility I would surmise that a very low cost intermediate term Muni fund would yield better returns over the long term because of the tax savings. So yea if I had a cool hundred million I might well go 50% VCADX 30% VTI and 20% Gold. The volatility would be a tad higher but long term I am guessing I'd come out ahead because I would be avoiding a 35% tax bite on half of my portfolio. And (yes I am prognosticating here) I seriously believe that taxes will eventually be going up. There is no way we can realistically get our debt under control through spending cuts alone.  But all of this is predicated on being wealthy and able to handle higher volatility.

On a side note I have absolutely no idea why anyone would speculate in Muni bonds for a VP but to each their own.

Thanks for your thoughts Ad Orientem. It's nice to see a particular argument FOR muni bonds. I was just trying to get good arguments for or against them.

And the reasoning I put this in the VP section was that I felt it didn't belong in any of the other sections. This is something my father was interested in as he is getting closer to retirement so wanted to get some more information on these particular types of bonds for him.

I pity the fool who's holding Stockton Muni bonds…

STOCKTON – Years after betting on a sustained housing boom to bankroll a waterfront redevelopment and dole out salary and benefit perks to city employees and retirees, Stockton cashed in its chips Tuesday in a plan that will lead it into bankruptcy.

The City Council voted to approve an austerity plan, including stopping bond payments and making deep cuts in retiree health care, as part of a plan to file Chapter 9 bankruptcy.

http://www.sacbee.com/2012/06/27/459189 ... -into.html

Pointedstick wrote: I pity the fool who's holding Stockton Muni bonds…

STOCKTON – Years after betting on a sustained housing boom to bankroll a waterfront redevelopment and dole out salary and benefit perks to city employees and retirees, Stockton cashed in its chips Tuesday in a plan that will lead it into bankruptcy.

The City Council voted to approve an austerity plan, including stopping bond payments and making deep cuts in retiree health care, as part of a plan to file Chapter 9 bankruptcy.

http://www.sacbee.com/2012/06/27/459189 ... -into.html

Stockton's plight is not news. I would be very surprised if their bonds had not been junk rated for a couple of years now. Most fund managers would be barred from holding them unless it were a junk bond fund. Private bond holders would hopefully not be blind to repeated credit downgrades, though one cannot dismiss the possibility. In general if one is going to buy muni bonds you should stick with a low cost mutual fund or ETF with a duration of no more than 10 years and ideally under 8. Vanguard (as usual) has some very well run muni funds.

All of which said, I will repeat that munis make no sense as an investment unless you are very wealthy and able to handle the increased volatility. But the argument that munis aren't safe just doesn't hold up under historical scrutiny. As a class investment grade muni bonds have a default rate well below 1/10 of 1% going back to 1970. Even during the worst years of the Great Depression default rates generally did not rise above 1%. Excluding Confederate debt from the Civil War only one state has ever defaulted on its debt and declared bankruptcy (Arkansas).

Muni bonds however are not default proof and do not offer the same protection against deflation that US sovereign debt does. So they are singularly unsuitable for a PP. Also the lower interest rate they pay makes them a poor investment for anyone other than the very wealthy. But for those fortunate enough to hold assets deep in the eight figures, or higher, and who can stomach some volatility, I would be hard pressed to argue against a low cost intermediate term muni fund constituting the core of their bond portfolio. When one considers the potential tax advantages for the super wealthy with only slightly increased long term risk, the argument starts to carry some weight.

Otherwise I would leave them alone.