Am I Clueless?

[Vincenzo Corleone]

I recently invested a chunk of money in a taxable account at Vanguard. Because I'm in a high tax bracket, some of the money went to Vanguard tax efficient equity mutual funds. For the bond portion of my asset allocation, I placed the remaining money in something that I thought would be tax-savvy; I placed it in a Vanguard tax-exempt, long-term bond fund for my state. This way, it would be sheltered from federal and state taxes. However, some things that I've been reading here and there have made me think that perhaps it would have been better if I put the money in the Vanguard Ltd-Term Tax-Exempt fund; the reason being that it is a short-term bond fund and is less sensitive to interest rates. From what I understand, it would have still been exempt from federal taxes but not from state taxes, is that right? Would I have been better off in the short-term bond fund?

Another question - I was thinking of structuring things in my tax-sheltered account such that a bulk of the money would be in a higher yielding fund (such as Wellesley or the high-yield corporate bond fund) - the idea being that whatever this would yield would then be used to fund the other funds, since my high income prevents me from contributing before-tax funds to the account; I'd still be "contributing" to the account. Of course, there is no guarantee that the high-yielding fund will gain consistently. The question - I've been looking at the Vanguard High-Yield Corporate fund as it yields 7.62%. I understand that because the bonds in this fund are below investment grade that there is a risk of issuers defaulting on their debt. However, when I did some research on the fund, I read that the Morningstar Risk Rating is "Below Average" and that the beta was .56 which I think is low. Is this fund too risky to place a higher % of my portfolio in it? When I read that the yield is 7.62% and that it is considered a below average risk I think, "wow that sounds too good to be true". Am I thinking that this fund is better than it actually is?

Last question - Is the Vanguard Value Index fund less tax efficient than the Vanguard Total Stock Market Index fund? Are the only ways to determine the tax efficiency of a fund the turnover rate and the yield?

Thank you very much!

Vincenzo

 

[brewer12345]

Ignore yield. What you really care about is total return.

I think you did fine in your taxable account. All of the VG equity index funds are very tax efficient, so I wouldn't spend a lot of time worying about it.

In the tax deferred account, I would not load up on the junk fund. Some junk is a nice addition to a portfolio, but don't get seduced by the yield and go overboard. Start with a portfolio allocation and then stick the tax inefficient stuff in the tax deferred accounts and the tax effcient stuff in the taxable accounts. So in the tax deferred accounts, I would stick junk, taxale bond funds, commodities, foreign bonds, stuff like MERFX, etc. but only to the extent you need to hold these assets to meet your target allocation. If you are still light on equities, there is no reason not to stick them in your deferred account if that's what your allocation is.

 

[LOL!]

How You Can Boost Your After-Tax Returns - WSJ.com is a recent article that's easy to read

I think an aid to determine the tax efficiency of a fund is to look at the history of distributions paid out during each of the last 10 years.

 

[walkinwood]

LOL! Thanks for the link
from the article
"A big reason for the performance gap: When stock funds are in the taxable account, dividends and capital gains are taxed at 15% -- vs. 35% on interest when bond funds are in that account."

Good old WSJ - why think that ANYBODY can have a top taxable rate of less than 35%?
(btw, I do know that the tax of dividends & cap gains are always less than that on interest)

 

[LOL!]

The reporters for the WSJ generally work/live in NY City, so their world outlook reflects that, just as mine now reflects simple suburban life in the south. When I moved to NY from Europe, I saw how NY-centric most of the reporting in national finance media is. Of course everyone pays at least 35% in tax because not only is there federal tax, there is that pesky 9% state income tax and the 4% NYC income tax. And homes always cost at least $500K. And all your children go to Columbia, Princeton, Yale or Harvard.

Nevertheless, I think the gist of the article was important: if you can put your fixed income in a tax-advantaged account, then do so.

I have not paid capital gains taxes in years. This results from tax-loss harvesting and avoiding realizing capital gains. I have also reduced my taxable dividend income to only the dividends from passive index ETFs like SPY, MDY, EEM, IWM. I have almost no bond dividends and use a tax-exempt MM fund, so I have no interest income anymore. For VC (our OP), I would not buy tax-exempt bond funds until I had 100% of my 401k and IRA and 529 plan money in a bond fund and still wanted a higher bond allocation.

 

[Vincenzo Corleone]

Thank you all for your feedback.