Tax-exempt state bond funds (risk?)

[LRAO]

I'm trying to figure out what risks there are to investing in tax-exempt bond funds, and if they could take the place of (total bond market) in someones portfolio?

I'm trying to maximize the "room" in my tax-deferred accounts for other tax-inefficient funds, like REITs, etc.

If it makes any difference, I live in California.

[brewer12345]

If you are buying state general obligation (GO) bonds, go crazy. They are pretty much default proof. If you are buying "project bonds", buy through a fund or stay away. Project bonds will also expose the income to AMT.

[wabmester]

Originally Posted by LRAO

If it makes any difference, I live in California.

If you're buying munis, obviously you'll want to buy those issued by your state in order to get both the fed and state tax breaks.

Of course, the yields on munis are generally lower than other bonds, so they only make sense if you're in a high tax bracket. Do the calculation for your bracket to ensure that they pencil out for you.

You can buy individual bonds if you plan to hold to maturity. Otherwise, buy a CA-specific muni fund (e.g., Vanguard's VCITX).

[brewer12345]

BTW, if you want to buy California state GO bonds, you are in luck. The secondary market in munis is thin, and brokers tend to skin retai customers alive. CA has thoughtfully put a slew of their issues on the NYSE (see http://www.nyse.com/scripts/absbonds/Bonds_Name_PDF.pdf). At Schwab, I can buy listed bonds for $2 a bond. No doubt other brokers offer similar pricing, which is much better than the screwing you would get bying bonds over the counter at your broker.

[LRAO]

Thanks.

Actually, I was asking with regards to VCITX.

So...any more thoughts on risk?

[ats5g]

Originally Posted by LRAO

I'm trying to figure out what risks there are to investing in tax-exempt bond funds, and if they could take the place of (total bond market) in someones portfolio?

I'm trying to maximize the "room" in my tax-deferred accounts for other tax-inefficient funds, like REITs, etc.

If it makes any difference, I live in California.

Thanks.

Actually, I was asking with regards to VCITX.

So...any more thoughts on risk?

Vanguard's California Intermediate-Term Tax-Exempt Fund [VCITX] is very similar to Vanguard's Total Bond Market Index Fund [VBMFX], in its duration, Distribution By Maturity, and Distribution By Credit Quality. So, one could probably subsitute one for the other.

Though, VCITX does carry State-specific risk:

The chance that developments in the state will adversely affect the securities held by the fund. Because the fund invests primarily in securities issued by one state and its municipalities, it is more vulnerable to unfavorable developments in this state than are funds that invest in municipal securities of many states

While the fund holds over 500 bonds, if California's credit quality starts to tank, VCITX could take more of a hit than say Vanguard's Intermediate-Term Tax-Exempt Fund [VWITX], which invests in municipal bonds from across the US, not just in one state. However, if VCITX is not a large portion of your bonds, then its' probably nothing to fret over that much.

- Alec