Ready
Thinks s/he gets paid by the post
I have some 5 year CDs that will be maturing this year and I need to decide what to do with them. They are all currently paying just a bit above 3%. And I just moved some money over to PenFed and established some new 5 year CDs as well.
I'm trying to evaluate the best options for the fixed income portion of my portfolio, which is 40% of my total investment portfolio. I currently have about half of my FI portfolio in Vanguard CA Municipal Bonds (VCADX). The SEC yield on this fund is currently 2.3%. The distribution yield is a bit higher, at 3.35%, but my understanding is that this is not the figure to use when evaluating the actual performance of the fund, as it may factor in short term swings in the NAV, and not reflect the long term expected yield on the fund. I may be getting that wrong though. No matter how many times I read about the differences between SEC yield and distribution yield, I still don't really understand it.
In any case, if I take the 2.3% distribution yield, and divide it by .7 (I pay 30% in state and federal taxes), this gives me an equivalent taxable yield of 3.29%.
So in effect I can currently earn 3% in a CD, guaranteed by the federal government, or earn 3.29% in a bond fund. But the bond fund is subject to interest rate risk, where the CD is not. Of course if interest rates go down, I could earn more than 3.29%, but the likelihood of this happening seems pretty low. If interest rates rise, the NAV will drop, meaning I'm really earning less than 3.29%, at least if I end up selling before the higher yield offsets the drop in NAV.
So in effect I'm comparing a guarantee of 3% to a yield of 3.29% with interest rate risk. It seems like a very small premium for all the risk. Am I looking at this correctly? Is there anything I'm not considering regarding the potential performance of municipal bonds? Would I do any better buying individual bonds and holding them to maturity. It seems like I would have the same issues, since I would lose money if I sold them, or suffer a below market yield for many years if I hold them to maturity.
And of course, there is no guarantee that the 3% CD will be available once PenFed resets their rates tomorrow. But I still want to make sure I'm looking at this scenario correctly and evaluating all of the pros and cons of each before making a decision.
May I ask for some input into my analysis of this, and any other suggestions you may have for fixed income investing.
Thank you.
I'm trying to evaluate the best options for the fixed income portion of my portfolio, which is 40% of my total investment portfolio. I currently have about half of my FI portfolio in Vanguard CA Municipal Bonds (VCADX). The SEC yield on this fund is currently 2.3%. The distribution yield is a bit higher, at 3.35%, but my understanding is that this is not the figure to use when evaluating the actual performance of the fund, as it may factor in short term swings in the NAV, and not reflect the long term expected yield on the fund. I may be getting that wrong though. No matter how many times I read about the differences between SEC yield and distribution yield, I still don't really understand it.
In any case, if I take the 2.3% distribution yield, and divide it by .7 (I pay 30% in state and federal taxes), this gives me an equivalent taxable yield of 3.29%.
So in effect I can currently earn 3% in a CD, guaranteed by the federal government, or earn 3.29% in a bond fund. But the bond fund is subject to interest rate risk, where the CD is not. Of course if interest rates go down, I could earn more than 3.29%, but the likelihood of this happening seems pretty low. If interest rates rise, the NAV will drop, meaning I'm really earning less than 3.29%, at least if I end up selling before the higher yield offsets the drop in NAV.
So in effect I'm comparing a guarantee of 3% to a yield of 3.29% with interest rate risk. It seems like a very small premium for all the risk. Am I looking at this correctly? Is there anything I'm not considering regarding the potential performance of municipal bonds? Would I do any better buying individual bonds and holding them to maturity. It seems like I would have the same issues, since I would lose money if I sold them, or suffer a below market yield for many years if I hold them to maturity.
And of course, there is no guarantee that the 3% CD will be available once PenFed resets their rates tomorrow. But I still want to make sure I'm looking at this scenario correctly and evaluating all of the pros and cons of each before making a decision.
May I ask for some input into my analysis of this, and any other suggestions you may have for fixed income investing.
Thank you.