Corporate Bonds vs Municipal Bonds

[Dash man]

We’ve just had a bunch of CDs mature are are putting most of the money into a bond ladder. We need to decide what kind of strategy to use for this bond ladder. We plan to be in the 24% tax bracket as we do Roth conversions for the next seven years. These bonds will be in a taxable account. We are considering intermediate term bonds for a 5-10 or 7-12 year ladder.
I know there are smarter folks out there than me when considering bond strategies. What would you recommend and why?

 

[jazz4cash]

I would compare the corporate bond yield to taxable equivalent yield for the munis given your expected tax bracket and the rating and stability for each. Munis seem to get favorable pricing at times but I’m not finding that to be true right now. Also consider taxable munis.

 

[njhowie]

Just my opinion/view...

Yields at this time will make you cry. In many cases, the buyer is not being sufficiently compensated for the inherent risk. At the end of the day, it's still a bond, and there is risk.

That being said, if you are new to bonds, you need to be careful. You need to understand any call or extraordinary redemption provisions, and what your yield to call would be if your bonds are called early. In general, at least in the municipal bond market, anything with a coupon of 5% or higher is being priced as though it will be called, and most carrying a near-zero, or even negative yield to call.

If you are new to bonds, now is not really the time you want to cut your teeth on them.

I am probably the biggest municipal bond fan around here. However, you need to be realistic with the environment we're working within.

 

[Dash man]

I would compare the corporate bond yield to taxable equivalent yield for the munis given your expected tax bracket and the rating and stability for each. Munis seem to get favorable pricing at times but I’m not finding that to be true right now. Also consider taxable munis.

To clarify, this will be a managed account at Schwab that will be picking and choosing the bonds based on the strategy we select.
We have to decide between munis and corporate and a general range of years for the ladder.

 

[njhowie]

To clarify, this will be a managed account at Schwab that will be picking and choosing the bonds based on the strategy we select.
We have to decide between munis and corporate and a general range of years for the ladder.

That being the case, you can ignore most of what I posted above.

However - how much is Schwab going to be charging you for this service? What are they telling you that you can expect as far as yields at this time?

 

[Dash man]

Just my opinion/view...



Yields at this time will make you cry. In many cases, the buyer is not being sufficiently compensated for the inherent risk. At the end of the day, it's still a bond, and there is risk.



That being said, if you are new to bonds, you need to be careful. You need to understand any call or extraordinary redemption provisions, and what your yield to call would be if your bonds are called early. In general, at least in the municipal bond market, anything with a coupon of 5% or higher is being priced as though it will be called, and most carrying a near-zero, or even negative yield to call.



If you are new to bonds, now is not really the time you want to cut your teeth on them.



I am probably the biggest municipal bond fan around here. However, you need to be realistic with the environment we're working within.

That’s why we’re letting the pros manage the account. We’re not expecting great returns, but hopefully a ladder will increase returns as rates rise.

 

[Dash man]

That being the case, you can ignore most of what I posted above.



However - how much is Schwab going to be charging you for this service? What are they telling you that you can expect as far as yields at this time?

Schwab will charge .35% for a municipal ladder and .55% for corporate bonds.

 

[njhowie]

Schwab will charge .35% for a municipal ladder and .55% for corporate bonds.

My major concern is in trusting them - how do they decide what bonds will be purchased? Do they just pick random stuff that falls within the maturity range you tell them? Are they giving you the garbage that's been hibernating in their inventory and they can't sell? Do they tell you what they're buying first and you have the ability to tell them if there are any you don't want them buying?

Is the 0.35%/0.55% a one time charge or annual? If it's annual, that's likely going to come to over 10% of the returns you'll make.

Sorry, I know that's not the question you asked. Just my paranoia peaking out.

 

[Dash man]

My major concern is in trusting them - how do they decide what bonds will be purchased? Do they just pick random stuff that falls within the maturity range you tell them? Are they giving you the garbage that's been hibernating in their inventory and they can't sell? Do they tell you what they're buying first and you have the ability to tell them if there are any you don't want them buying?

Is the 0.35%/0.55% a one time charge or annual? If it's annual, that's likely going to come to over 10% of the returns you'll make.

Sorry, I know that's not the question you asked. Just my paranoia peaking out.

No, this is a small company purchased by Schwab that are bond specialists. We attended a webinar a couple of months ago that impressed us. I’ve always been skeptical of bonds myself, but these guys from Wasmer Schroeder Strategies convinced us to give them a try.

 

[jazz4cash]

To clarify, this will be a managed account at Schwab that will be picking and choosing the bonds based on the strategy we select.
We have to decide between munis and corporate and a general range of years for the ladder.

I still don’t I understand why you need to choose between munis and corporate. I didn’t notice you were setting up a ladder.

 

[Dash man]

Is the 0.35%/0.55% a one time charge or annual? If it's annual, that's likely going to come to over 10% of the returns you'll make.

Sorry, I know that's not the question you asked. Just my paranoia peaking out.

It’s annual, and we realize it will reduce our return. But they are likely to pick better bonds and not make the costly mistakes I would probably make. But the return will still be better than a CD these days. We’re trying them out. If it doesn’t work out we can dump them.
I’ve always been comfortable with stocks, but not bonds. As we age, we will probably want more managed accounts. We’ve never paid anyone before, but are considering it now. I don’t want bond funds.

 

[pb4uski]

To clarify, this will be a managed account at Schwab that will be picking and choosing the bonds based on the strategy we select.
We have to decide between munis and corporate and a general range of years for the ladder.

If Schwab is going to be managing it for you I would also ask them about a portfolio of preferred stocks.... they typically often yield more than bonds by the same issuer. Ditto for baby bonds.

For example, a couple of J.P. Morgan preferreds are yielding in the mid-5% range and my portfolio is in the mid-5% range as well.

 

[pb4uski]

Another good bond or CD substitute are target maturity bond funds. Invesco has corporate and municipal versions. The 2026 maturty yield about 1.5% for the corporate version and 0.95% for the muni version.

 

[njhowie]

I still don’t I understand why you need to choose between munis and corporate. I didn’t notice you were setting up a ladder.

jazz - see info here...

https://www.schwab.com/wasmer-schroeder/bond-ladders

 

[jazz4cash]

Ok. That’s a non starter for me as I don’t want to be locked into one or another type of bond. My tax bracket is 22-24 so I see both taxable and tax exempt bonds that fit my objectives but not much at the present time. $250k is a big commit. Really, really BIG.

I wonder if my Fido guy is going to push me into a plan like this.

 

[Ready]

I have a substantial number of shares of municipal bond funds from Vanguard. I go with intermediate term, mostly California based so fed and state tax free. I know some people have concerns about the bond funds versus holding individual bonds but I’m not comfortable trying to buy individual bonds and over the long term historically both have returned about the same results. I don’t plant to sell my shares. I just live off the dividends (for now). So I’m not that concerned about interest rate risk.

 

[Dash man]

Ok. That’s a non starter for me as I don’t want to be locked into one or another type of bond. My tax bracket is 22-24 so I see both taxable and tax exempt bonds that fit my objectives but not much at the present time. $250k is a big commit. Really, really BIG.

I wonder if my Fido guy is going to push me into a plan like this.

I’m not trying to convince anyone to do this. I’m simply asking the good people here which would they recommend and why.

 

[njhowie]

I’m not trying to convince anyone to do this. I’m simply asking the good people here which would they recommend and why.

As I look at Fidelity's current fixed income yield matrix, when I compare corporates to munis of same maturity and same rating, at 10+ years the corporates are yielding more than the 0.2% differential in annual fees. At 5 years and under, the differential is less than the fee differential. So, based on the lay of the land today, that would imply going for the longer-dated corporate strategy. Going forward, as rates rise, likely so too will the spread between them.

So, all else being equal, it appears to slant in favor of the corporate strategy with 7-12 year maturities.

Now, take into account the taxable equivalent - it probably comes out as a wash at this time.


https://fixedincome.fidelity.com/ftgw/fi/FILanding

 

[Dash man]

As I look at Fidelity's current fixed income yield matrix, when I compare corporates to munis of same maturity and same rating, at 10+ years the corporates are yielding more than the 0.2% differential in annual fees. At 5 years and under, the differential is less than the fee differential. So, based on the lay of the land today, that would imply going for the longer-dated corporate strategy. Going forward, as rates rise, likely so too will the spread between them.

So, all else being equal, it appears to slant in favor of the corporate strategy with 7-12 year maturities.

Now, take into account the taxable equivalent - it probably comes out as a wash at this time.


https://fixedincome.fidelity.com/ftgw/fi/FILanding

Thank you!

 

[stephenson]

I know this is a bond question, but my solution last year was to skip investing in bonds entirely - I bought ATT whenever it provided a greater than 7.5% dividend.

I know this is not bond investing, but bond investing wasn't a reasonable thing to do at the time, so ....

 

[Dash man]

I know this is a bond question, but my solution last year was to skip investing in bonds entirely - I bought ATT whenever it provided a greater than 7.5% dividend.

I know this is not bond investing, but bond investing wasn't a reasonable thing to do at the time, so ....

We already have much more in dividend paying stocks than we are putting into bonds.

 

[OldShooter]

I'm not a bond guy really. We hold TIPS. But in reading this thread I am surprised that the word "diversification" does not appear. I am on the investment committee of a nonprofit where our philosophy is to buy and hold individual corporates to maturity. IIRC our portfolio is around $2-3M in bonds, with corporates usually bought in $10K pieces. I'm sure there are 100 different issues diversified across lines of business, geography, etc. The asset manager handles all this, but looking at it I can't imagine that an individual -- even with a large enough portfolio -- would want to do the research and management work. Hence your hiring an advisor, I guess, but how many issues do you expect to be able to hold and do you and they feel like that will be adequate diversification?

 

[Dash man]

I'm not a bond guy really. We hold TIPS. But in reading this thread I am surprised that the word "diversification" does not appear. I am on the investment committee of a nonprofit where our philosophy is to buy and hold individual corporates to maturity. IIRC our portfolio is around $2-3M in bonds, with corporates usually bought in $10K pieces. I'm sure there are 100 different issues diversified across lines of business, geography, etc. The asset manager handles all this, but looking at it I can't imagine that an individual -- even with a large enough portfolio -- would want to do the research and management work. Hence your hiring an advisor, I guess, but how many issues do you expect to be able to hold and do you and they feel like that will be adequate diversification?

We been shown some sample portfolios of existing accounts and they are well diversified among sectors, including some taxable municipal bonds.

ETA: The example for corporate bonds showed 35 different securities. I seem to recall them saying it would likely be between 30-50 securities in a typical taxable bond account. They expect to take 6-8 weeks to put all the money to work.

 

[OldShooter]

We been shown some sample portfolios of existing accounts and they are well diversified among sectors, including some taxable municipal bonds.

ETA: The example for corporate bonds showed 35 different securities. I seem to recall them saying it would likely be between 30-50 securities in a typical taxable bond account. They expect to take 6-8 weeks to put all the money to work.

That doesn't sound too hair-curling. I have seen a few arguments that 30-40 stocks gives adequate equity diversification. With bonds it probably also depends on the type. Insured munis, investment grade corporates, and junk probably each call for different diversification.

 

[Dash man]

No junk bonds at all. BBB is the lowest they go and no more than 60% will be BBB.