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taxable versus tax-exempt bond funds
Old 10-27-2006, 03:37 PM   #1
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taxable versus tax-exempt bond funds


I am a little confused about the performance differences between
taxable and tax-exempt bond funds. I understand the theory of
reducing the yields of the taxable ones by your tax bracket in order
to compare performance. But it appears to me that many of the
tax-free funds have yields and performance equivalent to the
taxable ones, and therefore it's a no-brainer to go with the tax-free
even if your tax bracket is low.

Just comparing Vanguard funds:
"total bond" VBMFX yield=4.76% YTD-rtn=2.88%
"long-term tax-exempt" VWLTX yield=4.54% YTD-rtn=3.88%
(these numbers are from yahoo-finance)

Both funds score "high" credit quality and "medium" interest-rate
sensitivity in the Morningstar style box (despite the name of the
tax-exempt fund).

Am I missing something ? Are the numbers above "data mining" ? Maybe so,
but my general impression is that the tax-exempt ones have similar yields.
Or is there something about the current enviroment that is making the
yields of taxable and tax-exempt be atypically similar ?


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Re: taxable versus tax-exempt bond funds
Old 10-27-2006, 04:28 PM   #2
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Re: taxable versus tax-exempt bond funds

Here's what Vanguard lists as the SEC Yield for the two funds:

VBMFX=5.04% (duration=4.6 yrs)

VWLTX=3.93%(duration=6.1 yrs)

So, the taxable fund has a 25% higher yield and lower duration.

And the spread seems about right given the current yield curves:

link
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Re: taxable versus tax-exempt bond funds
Old 10-28-2006, 01:14 PM   #3
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Re: taxable versus tax-exempt bond funds

John,

FWIW, here's how M* defines the "yield" it uses:

Quote:
Yield
Yield, expressed as a percentage, represents a fund’s income return on capital investment for the past 12 months. This figure refers only to interest distributions from fixed-income securities, dividends from stocks, and realized gains from currency transactions. Monies generated from the sale of securities or from options and futures transactions are considered capital gains, not income. Return of capital is also not considered income NMF--or No Meaningful Figure--appears in this space for those funds that do not properly label their distributions. We list N/A if a fund is less than one year old, in which case we cannot calculate yield.

Morningstar computes yield by dividing the sum of the fund’s income distributions for the past 12 months by the previous month’s NAV (adjusted upward for any capital gains distributed over the same time period).
and Here's how Vanguard defines the yield it posts on its website:

Quote:
A — THIRTY DAY ADVERTISED YIELD NET OF EXPENSES CALCULATED DAILY
For comparing investing in either fund as of now, I think Vanguard's yields represent the best comparison, as they are roughly the standardized yield that an investor can receive in the future. So, Vanguard's bond fund yields are taking the interest for the last 30 days and annualizing them, which would be what you'd expect to received in income over say the next year.

- Alec
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Re: taxable versus tax-exempt bond funds
Old 10-28-2006, 01:32 PM   #4
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Re: taxable versus tax-exempt bond funds

Also, be careful with tax exempt bond funds -- some of them include private activity bonds whose interest is subject to the AMT -- so you can end up paying some income tax if you get pushed into the alternative minimum tax fun-filled forms.
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