Online Savings Account vs Brokerage Account with Bond Funds

[mountainsoft]

As of yesterday my Discover online savings account dropped to 1.25% interest. I like having at least a years worth of expenses in FDIC protected savings, but figured I would invest any extra I have in my taxable brokerage account.

VBTLX seems to average around 3-4% interest over time (5% this year I think), so for now I invested my extra savings in VBTLX.

I know bonds aren't usually recommended in taxable accounts, but it should be taxed at the same tax rate as my online savings account right? So no difference other than earning a bit more interest with a bit more risk. This is money we may need in the short term, so I don't want to invest it in stocks.

Are there any other downsides to having VBTLX in a taxable brokerage account I'm not thinking of?

 

[gwraigty]

We have bonds in our taxable and tax advantaged accounts. One "downside" to having them in a taxable account is the potential for a little more tax bookkeeping work. For example, if the fund has a mix of bond types that are taxed differently for state purposes, then you might have to hunt down that info at tax time. Most companies are good at providing it. For example, Treasury income is taxed federally, but not at my state level. Right now the Vanguard page says that 43% of VBTLX is Treasury/Agency. Let's pretend it just says Treasury, because Agency securities aren't all taxed the same either. Let's also assume that the other 57% of the mishmash is fully taxable for both federal and state tax purposes. If VBTLX paid $1,000 in dividends and Vanguard reported those same percentages at tax time, then $430 would be attributable to Treasuries and $570 would be everything else. I'd make an adjustment deduction on my state income taxes for that $430 that would be included in my federal AGI.

It gets more complicated if you have munis in a bond fund, so let's not go there right now.

 

[mountainsoft]

One "downside" to having them in a taxable account is the potential for a little more tax bookkeeping work. For example, if the fund has a mix of bond types that are taxed differently for state purposes

We don't have state taxes here in Washington. Are there any implications for federal taxes other than being taxed at the normal tax rate (same as my savings account right?).

 

[audreyh1]

VBTLX is currently only yielding 1.5% and that will continue to drop for a while.

 

[Sunset]

One disadvantage is should interest rates rise (unlikely in near future) the VBTLX will drop a multiple of the rise in rates.

I'm not a bond guy but I'm thinking, since avg duration is 6.3, it would drop about 6 x the interest increase.

 

[gwraigty]

We don't have state taxes here in Washington. Are there any implications for federal taxes other than being taxed at the normal tax rate (same as my savings account right?).

My quick answer w/o doing research is probably not.

 

[pb4uski]

VBTLX is currently only yielding 1.5% and that will continue to drop for a while.

One disadvantage is should interest rates rise (unlikely in near future) the VBTLX will drop a multiple of the rise in rates.

I'm not a bond guy but I'm thinking, since avg duration is 6.3, it would drop about 6 x the interest increase.

+1 The 3-4% that you are seeing includes increases in value resulting from declining interest rates... that is why recent returns have exceeded the portfolio yield.

I wouldn't view VBTLX as being a suitable substitute for an online savings account or short-term CD.... too much interest rate risk for my tastes (though I concede that Ihave been thinking that for years).

If interest rates are flat, you'll probably yield ~1.5%... not much more than the online savings account.

 

[audreyh1]

One disadvantage is should interest rates rise (unlikely in near future) the VBTLX will drop a multiple of the rise in rates.

I'm not a bond guy but I'm thinking, since avg duration is 6.3, it would drop about 6 x the interest increase.

It’s not that simple. There is a yield curve that has different rates at different durations. The yield curve usually changes shape as rates rise and fall. It has actually happened in the past the intermediate rates held steady or dropped while short rates climbed. You never know how it’s going to play out.

Personally I don’t worry much about interest rate risk as I hold my bond funds way past their duration. I have some cash and short-terms bond funds as well, but otherwise I focus on quality.

 

[mrfeh]

I wouldn't view VBTLX as being a suitable substitute for an online savings account or short-term CD.... too much interest rate risk for my tastes (though I concede that Ihave been thinking that for years).

+1

Total bond should not be used for short-term savings.

 

[mountainsoft]

Total bond should not be used for short-term savings.

Maybe I should rephrase that as medium-term savings. We have a years worth of living expenses in savings (more than two years once my wife starts her pension). I've already maxed out our retirement contributions, so this is extra money I'm looking to invest. It's not something we'll need in the next year or two, but it's not something that will sit for 10 years either. If an emergency comes up I want to be able to withdraw it quickly. That's not really an option with a CD and they aren't paying much more than regular savings anyway.

VBTLX may not be the ideal long term answer, but right now it has managed to perform fairly well through the first part of this year. I can always switch to something else later if the situation changes. It's not a huge sum of money anyway, so I'm willing to risk it a little to see how it compares to regular savings.

 

[mrfeh]

Maybe I should rephrase that as medium-term savings. We have a years worth of living expenses in savings (more than two years once my wife starts her pension). I've already maxed out our retirement contributions, so this is extra money I'm looking to invest. It's not something we'll need in the next year or two, but it's not something that will sit for 10 years either. If an emergency comes up I want to be able to withdraw it quickly. That's not really an option with a CD and they aren't paying much more than regular savings anyway.

VBTLX may not be the ideal long term answer, but right now it has managed to perform fairly well through the first part of this year. I can always switch to something else later if the situation changes. It's not a huge sum of money anyway, so I'm willing to risk it a little to see how it compares to regular savings.

Generally speaking, you should plan to hold a bond fund for the average duration of the fund. For total bond, that's usually around 6 years.

VBTLX has done well because rates have fallen drastically this year. I wouldn't expect that to continue.