Exchange VBTLX For VWAHX

Reader Question

Hi LTR, I love the blog! It's extremely well written, and makes things about Wall Street much simpler to understand for the average investor. Thanks for doing it. I'm a 30-something, relatively new investor, and I hold the following Admiral shares in a taxable brokerage account at Vanguard: 45% VTSAX, 30% VTIAX and 25% VBTLX; aka your "risk taker" portfolio choice. Total of about $65k in this account, with another large contribution between $20-40k coming later this year/early next year. After a few months into it, I am looking at the tax ramifications of holding VBTLX in this taxable account, and I wanted to get your specific opinion of exchanging this fund for the Vanguard High-Yield Tax Exempt Municipal Bond fund (VWAHX). I do recall your sage advice of making the decision and then sticking with it, but it seems like the taxes on VBTLX will eventually eat my returns up. Unfortunately, I do not (right now, at least) have the requisite $50,000 needed for the Admiral shares version (VWALX) though I probably will be able to do the Admiral upgrade later this year or early next year. Should I make this exchange? Should I keep some % of my portfolio in VBTLX, or just go ahead and exchange all of it? I would like to hear your thoughts on this. Keep up the good work!

My Reply

Thanks for writing. I really appreciate the feedback letting me know that my blog is useful -- it's the best motivation for me to keep it going.

Your plan to exchange VBTLX in taxable account for a municipal bond fund is a very good one. The only reason I don't mention this idea every time I write VBMFX/VBTLX is because I don't want to be overly repetitive (almost every post in this blog is a rehash of the same themes already) and to be a bit more concise. But I hope I mentioned it often enough because it is absolutely the way to go. As I recently wrote in another post, even if you have VBMFX/VBTLX in a tax-advantaged account, it could still make sense to swap it for a municipal bond fund in taxable account and use the tax-advantaged account for equities. In your case, with VBMFX/VBTLX is in taxable space to begin with, you should absolutely swap it for a muni fund.

The only question is which muni fund to select. Although Vanguard's idea of "high-yield" muni fund still has quite high credit quality, it would be a noticeable downgrade from VBMFX/VBTLX. It's not necessarily a problem, but when the next crisis hits it is likely that Vanguard's High-Yield muni fund dips along with equities and other "risky" investments while VBMFX/VBTLX will maintain its value or even rise slightly as a "safe haven". I don't think it's a major consideration, but some people are very averse to even the smallest drops in their fixed income holdings. They may also want to have more of a chance to rebalance from appreciated bonds to beat-up equities in a crisis. If this concerns you, you may want to use Vanguard's higher credit quality muni fund VWLTX/VWLUX which is more likely to hold its value in a crisis in exchange for slightly lower yield. That lower yield is still higher than VBMFX/VBTLX -- even before taxes are considered!

If you are not already doing it you should consider maxing out your annual allowance of I Savings Bonds ($10,000 per year per Social Security number) through TreasuryDirect.gov. I Savings Bonds combine the safety of US federal government's backing, high liquidity and perfect safety from rising interest rates (can be redeemed after a year for face value with only a small penalty), deferred taxation, and yield that is almost certain to beat VBMFX/VBTLX and has a chance to beat muni funds as well. The I-Bonds are almost certainly the best "deal" going in fixed income space today, so I would max them out before looking into any other fixed income investments.

Finally, and again if you are not doing it already, make sure you also max out tax-advantaged accounts -- 401k, Roth IRA, Traditional IRA -- before investing in taxable.