Should I invest in VCAIX? Convince me otherwise!

[ganda]

I'm looking for somewhere to put $300K for the next 18-20 months. We are 'high income' CA residents, so I've been looking at Vanguard's California Intermediate-Term Tax-Exempt Fund. Anyone use it?

I'm feeling stuck between the rock of not wanting to lose capital and the hard place of not wanting to accept paltry 2% returns

Alternative suggestions warmly welcomed.

(BTW, the 20 months duration is because we're leaving CA next fall )

[charlie]

ganda,

You might look in to I- Bonds. I think they are tax
exempt at the state level and you can defer
fed tax until you redeem them. A married couple
can buy $120k worth in one year by buying $60k
of the "paper" kind and $60k of the "paperless".
I-bonds will not be exposed to capital gains loss
like intermediate term bonds. You have to hold
them for 1 year before they can be cashed and
you will pay a modest interest penalty if cashed
before 5 years (3 months?) . I- bonds will be a
good hedge against rising interest rates and
inflation, IMHO.

Good luck,

Charlie (aka Chuck-Lyn)

[ganda]

With the $120K/year limit we'll be wanting to cash out before we've bought them all. Not too fond of early redemption penalities either. Thanks for the suggestion though.

[charlie]

ganda,

I looked up VCAIX on Vanguard's website and
found that the fund's "duration" is 4.8 years.
This means that for every 1% rise in interest
rates the fund will have a 4.8% capital loss.
IMHO, a 1% rise is very possible in the next
20 months. You mentioned that you did not
want to risk losing capital., which was why I
suggested you invest some of your stash in
I-bonds. Another thought is to use VCTXX.
It pays 0.98% right now but it will not lose
capital when interest rates rise. .... and, IMHO,
they will within the next 20 months.

Cheers,

Charlie (aka Chuck-Lyn)

[cute fuzzy bunny]

Besides the interest rate risk, there is also risk of default in muni's, and california has seen better days economically...although things seem to be looking up.

Paltry 2% returns beat the heck out of 10% losses.

Perhaps the limited term tax exempt fund?

There just isnt a safe yield right now that I think anyone would feel good about recommending.

[ganda]

Can you really make such a direct link? Looking at the value of the fund units over the last 8 years, the price has remained within a pretty narrow window (less than 10% movement). There has been some big movement on interest rates those past 8 years...

[cute fuzzy bunny]

5% drop in 1994 and a 6% drop in 2000 in response to rising rates.

Given that we started those rate rises at already a pretty decent interest rate level, and we're at 1%, I'd submit you could count on at least a 5% drop within the next 12-18 months.

If you invest in this fund there is a good chance that you will have a capital loss when you sell it.

If you plan to roll the money over into a similiar muni-fund, and expect to have cap gains to offset a possible loss then buying the fund is reasonable.

If you're OK with the risk, go for it.

In general, I would not park money in a intermediate term fund if I'm planning to sell in 20 months. I'd go for a shorter term fund, and accept the lower return, until I can invest the money for a longer duration.

I'm in a similiar situation, except that I'm not moving, so don't need to cash out soon. I'm planing to move into intermediate state munis, and I-Bonds.

[ganda]

Awwww, poo. I think I'll just stuff 20s under the mattress

[cute fuzzy bunny]

Invest in new mattresses.

Quote:

Awwww, poo. I think I'll just stuff 20s under the mattress *

You asked to be talked out of the investment. In this case it wasn't very difficult.

BTW: I was reading though "The Four Pillar's' yesterday, and Berstein makes an important point that the risk of a same state muni fund is even higher than a national fund of the same quality and duration. The reason being that financial problems tend to concentrate geographically.

That said, in my view, the tax advantages outweigh the risks. However, for tax efficient investing, he recommends using both the CA fund, and intermediate muni fun.

Good luck.

--JB