Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, May 2, 2016. You can also find the re-balance calendar for 2015 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Tax Free Municipal Bond Funds & Portfolios

Tax free bonds are usually debts issued by local governments that include cities, counties and state level government organizations. Thus, they are also called municipal bonds. The interests of these bonds are usually federal income tax exempt. Furthermore, they are also state income tax free if you purchase those bonds issued by municipals in your state. Note the capital gains you derive from price appreciation of municipal bonds or bond funds are not tax exempt and they are still subject to the usual short or long term capital gain tax. 

However, the benefits of municipal bonds are more than just tax free. 

Benefits of Municipal Bonds

In addition to the tax free benefit, municipal bonds are usually held by investors who are at high tax brackets. In fact, they are mostly held by retail individual investors. For example, because of the tax treatment, most hedge funds and trading corporations don’t have incentive to hold these securities. Because of this, municipal bonds are actually more stable and less volatile. This actually makes it far easier to construct a good  municipal bond fund portfolio, as can be seen shortly. 

Because municipal bonds are usually for local community projects such as roads, hospitals and schools, they enjoy powerful support from local communities. When these bonds encounter difficulties, local citizens usually call for help from other government entities including their higher up county governments and state governments. Precisely because these bonds are closely related to daily local life and economy, Federal government can also serve as the last back stop to help out (though not without negotiations and outcry from other tax payers). This again serves as a very important stabilizer for these bonds. 

Traditionally, local economy is strongly tied to national economy. For example, before and right after the financial crisis in 2008-2009, municipal bonds were hit hard because local government revenue was very much dependent on real estate related tax. However, as economy continues to improve, local municipal fiscal situations have also recovered. Some of them have done very well. A good example is the state of California that was on the brink of bankruptcy several years ago but now is cash flow positive thanks to local high tech economy and the booming real estate market. 

Interestingly, in the past 10 years, municipal bonds have had a similar return compared with taxable bonds: 

Municipal bond vs. taxable bonds (as of 4/25/2016):

Bond Funds Annualize Yield 1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 2.91% 4.3% 3.2% 4.9% 4.6% 1.39
VBMFX (Vanguard Total Bond Market Index Inv) 2.42% 1.8% 2.0% 3.5% 4.8% 1.01

Note: Currently, the intermediate term municipal bond fund has a higher 12 month yield than its taxable bond counterpart. This is partially due to the extremely low interest rate policy the Federal Reserve is implementing. Furthermore, the municipal bond fund actually has a higher 10 year Sharpe ratio, even though it had a higher maximum drawdown that was incurred in 2008 (8.2% vs. VBMFX’s 5.4%). 

Even without tax benefit consideration, the municipal bond fund has a better return for the past 1, 3, and 5 years and closely matches VBMFX for the 10 year period. 

Municipal Bond Fund Portfolios

Because of the properties discussed above, we believe that one can construct a portfolio that takes advantage of more steady trends exhibited in muni bonds. To construct such a portfolio, we use candidate funds that cover short, intermediate and long term municipal bonds, as well as high yield municipal bond funds that have higher risk but higher returns. The goal here is to cover both interest rate risk and credit risk, the two major risks in any debt investment. 

Similar to our total return bond fund portfolios (see those listed on Brokerage Investors page), we customize portfolios specific to individual brokerages. Our process is to use one (at most two) bond fund(s) to represent short, intermediate and long term (interest rate risk) and then one fund for muni high yield bonds. As always, these funds are no load, no transaction fee funds for a brokerage. Furthermore, if it is possible, we use low cost index funds. 

Vanguard Muni Bond Funds portfolio uses the following four Vanguard index funds: 

Vanguard Tax Free Candidate Funds: 

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR
VWSUX (Vanguard Short-Term Tx-Ex Adm) 0.4% 0.8% 0.6% 0.9% 2.0%
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 1.8% 4.3% 3.2% 4.9% 4.6%
VWLUX (Vanguard Long-Term Tax-Exempt Adm) 2.4% 5.8% 4.4% 6.5% 5.1%
VWAHX (Vanguard High-Yield Tax-Exempt) 2.3% 5.6% 4.4% 6.8% 5.1%

The portfolios are rebalanced each quarter, making them satisfy the minimum holding period (usually 3 months) required by a brokerage. Because its excessive 6 month minimum holding requirement, we do not advocate and construct a portfolio for TDAmeritrade. 

The following shows the five portfolios for five major brokerages: 

Portfolio Performance Comparison (as of 4/25/2016):

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
Fidelity Muni Bond Funds 3.5% 7.0% 4.6% 8.4% 6.9% 2.05
Schwab Muni Bond Funds 3.5% 7.0% 4.6% 8.4% 6.9% 2.05
Merrill Edge Muni Bond Funds 2.4% 5.0% 3.5% 6.4% 5.9% 1.95
Etrade Muni Bond Funds 2.4% 5.0% 3.5% 6.4% 5.8% 1.93
Vanguard Muni Bond Funds 2.3% 5.5% 3.3% 5.4% 5.0% 1.86
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 1.8% 4.3% 3.2% 4.9% 4.6% 1.39


See year by year detailed comparison >> 

A few more details:

  • Both Schwab and Fidelity use all Nuveen’s municipal bond funds as candidate funds. Nuveen is perhaps the best (or one of the best) municipal bond management company. It specializes in muni bond investing. Both brokerages have Nuveen’s muni bond funds as no load and no transaction fee funds. 
  • Unfortunately, we again find scattered availability of muni bond funds in both Merrill Edge and Etrade. We thus use a combination of T. Rowe Price muni bond funds (for long term and high yield bonds) and USAA’s muni bond funds (for short and intermediate term bonds). 
  • PIMCO is known for its bond investing prowess. However, because of its high expenses, we don’t find their funds appealing. 
  • As stated, we use all Vanguard low cost funds for Vanguard portfolio. 
  • As time goes, we will review and add/delete candidate funds from these portfolios as necessary.
  • The returns of these portfolios include both tax free interests and price capital gains, which are taxable. 

Currently, all these portfolios are advanced portfolios, requiring an expert subscription to follow.

All candidate funds are muni bond funds or so called national municipal bond funds. Their interests are mostly federal tax free. Users can also customize these portfolios by substituting funds with their own state muni funds to get further state and local income tax benefit. 

From the above discussion, one can see that in some situations (for example, right now), even in a tax deferred account such as an IRA, municipal bonds can be advantageous. 

Finally, from both our total return bond fund portfolios (for taxable bonds) and the above tax free bond portfolios, we can see that their 10 year returns are better or close to that of S&P 500 (VFINX’s 10 year annualized return is 6.9%). Looking back (and ahead because of the current stock overvaluation, as we have discussed several times before), it does not pay to take excessive risk. 

Market Overview

Stocks are again stalled because of a lackluster earning picture. Based on the latest Factset report (on 4/22/2016 last Friday), for Q1 2016, 26% of the companies in S&P 500 index have reported earnings. The blended earnings (reported and the estimated for those yet to report) for Q1 2016 declined -8.9% compared with a year ago.  Furthermore, even excluding the biggest distractor: energy sector, the remaining earnings declined -3.6%. However, companies borrow (cheap) money to buy back shares. Doing so, companies manage to prop up earnings per share (EPS) by shrinking the number of shares.  Investors are ‘encouraged’ by the fact that EPS growth is still positive. Talk about financial engineering!

For more detailed asset trend scores, please refer to 360° Market Overview

We would like to remind our readers that markets are more precarious now than other times in the last 6 years. Since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Even though U.S. stocks have had a recent correction, their valuation is still at a historical high level.  It is thus not a good time to take excessive risk. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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