Income from VWLUX

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I am hoping to get some people's opinions on an income investment that I am considering...

The Vanguard Long-term Tax-Exempt Fund (VWLUX) has been paying a $0.52 annual dividend for the last couple years and at it's recent price this would be a 4.58% annual income yield.

Couple of questions:

1) Does this seem like a pretty good "rate" given that taxable CDs are at only about 5.25% (given that I expect I may be paying a 5.5-6.0% State and 25% Federal tax rate over the next few years)?

2) Would it be reasonable to assume that any separate, fund Capital gains or losses would be something of less importance if I planned to keep the fund for 10 years and could hold it longer if needed?

Thanks for your opinions and advice.

 

[Gone4Good]

The formula to determine tax equivalent yield is:

Muni Yield / (1 - (Federal MR + State MR * (1 - Federal MR)))

VWLUX current yield is 3.95%. Assuming 25% Federal and 6% state, your taxable equivalent yield for VWLUX is 5.6%.

So you're getting an extra 35bp over current CD rates to move from a security with perfect price stability to one that will move 6.5% for every 100bp move in interest rates. It doesn't sound like a compelling investment, but there certainly could be reasons to take the slightly higher yield and volatility.

Another point worth noting is that not all muni interest is tax free. A portion of the interest earned on a general muni fund like VWLUX will be taxed at the state level and a portion could be taxed at the federal level if you are subject to the AMT. See if you can find out how much of the fund is invested in muni's issued by states other than you're own . . . the interest on those obligations will be taxable at the state level. It looks like VWLUX only has 2.8% that is subject to the AMT.

 

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Thank you for your insight and for the important points that you make. I'm just learning about this topic

The 6.5% value change vs. 100bp interest move comment was something I did not know how to calculate. Advice on how to figure that out would be appreciated. (thanks)

 

[Alex]

Thank you for your insight and for the important points that you make. I'm just learning about this topic

The 6.5% value change vs. 100bp interest move comment was something I did not know how to calculate. Advice on how to figure that out would be appreciated. (thanks)

Morningstar has a calculator that makes it a bit easier to calculate: http://screen.morningstar.com/BondCalc/BondCalculator_TaxEquivalent.html?tsection=toolsbondcal

 

[Gone4Good]

Thank you for your insight and for the important points that you make. I'm just learning about this topic

The 6.5% value change vs. 100bp interest move comment was something I did not know how to calculate. Advice on how to figure that out would be appreciated. (thanks)

Fortunately mutual funds do all the math for you. A fund's "duration", expressed in years, is the % change in price for every 100bp move in yield. VWLUX has a 6.5 year duration, so it will increase / decrease in price for every 100bp decrease / increase in yield.

 

[JB]

You will need to pay state taxes on the dividends from VWLUX. Look at the state specific fund for your state to eliminate those taxes.

I've held the intermediate muni for a long time and am very happy with it. I also chased some higher CD yeilds over the past few years. With CDs you may get a higher yeild but consider the hassle factors and penalty for early withdrawal. Also, with many banks you need to make sure you get your money out within 7 days after the CD matures. Otherwise they'll automatically reinvest at the non-promotional rate.

 

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Thank you to all of you for the education and advice. Great input!