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, March 13, 2017. You can also find the re-balance calendar for 2017 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 Investments Review

We introduced our tax free municipal bond portfolios in April last year April 25, 2016: Tax Free Municipal Bond Funds & Portfolios. In this newsletter, we will review and discuss these investments.

First, let’s briefly recap the benefits of municipal bond investments. The following is the synopsis of the benefits. 

  • Tax free municipal bonds enjoy federal tax free for their interests or dividends. For state sponsored municipal bonds, they also enjoy tax free for the state that issues these bonds. Thus, they are attractive to high tax bracket investors. 
  • Most tax free municipal bond investors are high tax bracket individual investors, making these investment free from professional or institutional traders. Thus they are often more stable and exhibit more stable price trend. This property makes the trend based tactical investment strategy suitable. 
  • However, before the tax free consideration, these bonds sometimes can have very comparable or even higher interests. Thus, sometimes, these bonds can be even useful for taxable accounts. So these investments shouldn’t be easily discarded completely by tax unconscious investors. 

2016 Municipal Bond Portfolio Performance

First, let’s look at the municipal bond segment performance: 

Portfolio Performance Comparison (as of 2/3/2017):
Ticker/Portfolio Name 2016 1Yr AR 3Yr AR 5Yr AR 10Yr AR
VWSUX (Vanguard Short-Term Tx-Ex Adm) 0.4% 0.4% 0.6% 0.7% 1.7%
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 0.0% -0.9% 3.0% 2.6% 4.0%
VWLUX (Vanguard Long-Term Tax-Exempt Adm) 0.1% -0.6% 4.4% 3.6% 4.4%
VWAHX (Vanguard High-Yield Tax-Exempt) 0.5% -0.3% 4.6% 3.9% 4.5%
VBMFX (Vanguard Total Bond Market Index Inv) 2.3% 1.0% 2.2% 1.9% 4.2%

From the above, we make the following observations:

  • In late 2016, municipal bonds went through a steep correction. The correction started in September and then went through big loss in November. This was mostly caused by the rising interest rate scare.
  • As of today, these bonds recovered somewhat, but they are still generally in a slight down turn. 
  • They all underperformed the general taxable bond index (VBMFX). 

Fortunately, the brokerage specific portfolios listed on Brokerage Investors (What We Do -> Brokerage Investors) mostly outperformed VBMFX in 2016:

Portfolio Performance Comparison (as of 2/3/2017):
Ticker/Portfolio Name 2016 1Yr AR 3Yr AR 5Yr AR 10Yr AR
Fidelity Muni Bond Funds 2.6% 1.5% 6.1% 5.7% 6.1%
Schwab Muni Bond Funds 2.6% 1.5% 6.1% 5.7% 6.1%
Merrill Edge Muni Bond Funds 2.6% 1.6% 5.2% 4.5% 5.3%
Etrade Muni Bond Funds 2.6% 1.6% 5.2% 4.5% 5.2%
Vanguard Muni Bond Funds 1.3% 0.0% 4.1% 3.3% 4.7%
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 0.0% -0.9% 3.0% 2.6% 4.0%
VBMFX (Vanguard Total Bond Market Index Inv) 2.3% 1.0% 2.2% 1.9% 4.2%

We attribute the portfolios’ outperformance to their capture of big upside in more risky high yield or long term muni bond funds which, even after the big correction in November, still edged out additional returns compared with VBMFX.  

These municipal bond portfolios also outperformed VBMFX for the past 1, 3, 5 and 10 years. 

Municipal bond investing outlook

Looking forward, there are two major headwinds facing municipal bonds:

  • The rising interest rate: the rising rate trend seems to be in place. This in general can hurt all bonds including municipal bonds. 
  • Trump’s lower tax rate could diminish the allure of municipal bonds. 
  • Trump’s proposed infrastructure spending could make more tax issuance and thus, again, making investors demand higher interest payment. 

However, municipal bonds have several advantages over taxable bonds:

  • Lower probability of default for municipal bonds: bsed on Moody’s, the probability that a lower-rated investment-grade municipal bond will miss a timely principal or interest payment in 2017 is only 0.4%, much lower than 4.0% for a corporate bond of similar credit quality.
  • The proposed infrastructure spending is mostly federal spending that combines tax incentives to encourage private or for profit projects. It’s very unclear and of course not certain that such infrastructure spending will increase much the issuance of muni bonds. 
  • Rising interest rate trend is not completely baked in, as we stated previously. The new administration’s policies are facing so many uncertainties and it’s far from certain that the policies will materialize and succeed. This can create and affect economy growth adversely. Low interest rate environment may be here longer than many think. 

The takeaway from the above is that, in the coming years, we view the active investing strategies such as the one employed in our portfolios will shine as they can avoid big loss (when interest rates rise sharply) and take advantage of the rising trend out of the lower prices reached in a correction. On the other hand, if interest rates stay low for a long period of time, our strategy will stay on the up trend and reap the benefit. 

Market Overview

Last week, stocks and bonds all rose modestly. Investors are still in a mood to hang on the up trends in all major assets. Bonds continue to recover too. We have no idea whether the trend will end next week or next month. However, we are cautious and be prepared for such an eventual event. Again, stay the course. 

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

Now that the Trump administration is officially sworn in, the new president is facing the reality to deliver his many promises to make substantial changes. As the nation is posed to invest, the most important factor to watch is how productive the investments will be. Simply put, productive investments will result in better return on investment (ROI), tangibly or intangibly. They should also increase productivity that in turns will improve our standard of living. Capital misallocation can result in a higher growth but might not improve the real standard of living, which is the ultimate goal of economic activities. Whether the new president can truly achieve this goal is still yet to be seen. One thing is certain: we will see more market volatilities. 

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

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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