CA Muni Bond Fund - Intermediate Term Strategy for High Earner?

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I had been stockpiling ~$500k cash for a downpayment on a multi-unit deal but it recently fell through. However, I'm still planning to deploy the cash 3-5 years out from now (maybe sooner if I find a good deal). 

Here's a quick summary:

  • Cash has been sitting in 1% savings accounts
  • Will be at the highest federal tax bracket (39.6%) for the next 2-3 years
  • Will be in the 11.3-12.3% CA income tax bracket for the next 2-3 years
  • Looking to deploy the cash into real estate in next 3-5 years
  • CA has no long term capital gains rate (all income is taxed the same)

I'm looking for better options than 1% accounts (close to ~0.5% after federal/CA taxes). I've been looking into VCAIX (Vanguard CA Intermediate Muni Bond Fund) and VCITX (Vanguard CA Long-term Muni Bond Fund) as a good place to park the money. It'll shield from both federal and state taxes while yielding much better than the non-tax advantaged 1% accounts. What's my downside here? Massive CA defaults if we head into a recession? Interest rate risk (the intermediate bond fund should mitigate this a bit)? Are there other avenues I should be investigating?

I'll be asking around my network for ideas and report back what I hear. 

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CalPERS posted returns of 0.61% last year, the average return needed to stay solvent is 7.5% per year. This will lead to... (more)

jayK (Jul. 19, 2016 @ 3:19p) |

Are you saying that you expect CA municipalities to default on their bonds because of CalPERS?

sfchris (Jul. 26, 2016 @ 9:18a) |

Yes, municipalities who don't address the unfunded pension liability issue are more likely to default. The pension debt ... (more)

jayK (Jul. 26, 2016 @ 9:48a) |

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It looks like a good option to me. There is some risk but you're aware of that and can afford to take it.

Look into unfunded pension liabilities in CA. A lot of municipalities in CA have a ton of unfunded pension liability, and without serious reforms you will see a lot of muni bondholders getting stiffed.

You're asking us if you should loan the money to a state with an out of control spending problem and up to their eyeballs in debt while you wait to invest in a housing bubble?

brettdoyle said:   You're asking us if you should loan the money to a state with an out of control spending problem and up to their eyeballs in debt while you wait to invest in a housing bubble?
 
jayK said:   Look into unfunded pension liabilities in CA. A lot of municipalities in CA have a ton of unfunded pension liability, and without serious reforms you will see a lot of muni bondholders getting stiffed.
  
I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.

My choice would then be between the CA Intermediate Muni Bond Fund or the more general Intermediate-Term Muni Bond Fund. The CA-only fund outperforms the general one on YTD, 1, 3, 5 and 10 year metrics. The general one outperforms the CA-only one since inception, but I think this is mostly due to the fact that the general one started back in 1977 when interest rates were much higher and the CA-only started in 1994. This is without taking into account the preferential tax treatment of the CA. Unless there's some hugely disproportionate risk with CA-only bonds I'm still leaning towards them.

Vanguard comparison 

Why not buy individual muni bonds? That way you can pick and choose which municipalities you want to invest in. As I'm sure you're aware if rates rise, the value of the bond fund is going to drop as well - and we are at historically low interest rates.

And these funds only yield 1.2%ish. I'm not sure if the added risk is worth 0.6% more (after tax) - and the fact that if you stick the money in an online savings account, you can increase your rates as rates go up. I mean you could always go with the stable blue-chip high dividend stocks like T ect but you've got even more risk there (although much more reward too).

OP - are you subject to AMT? that can change things.

I have lots of muni bond funds...i mostly do ETFs and CEFs, some leveraged. some are AMT-free.

I can tell you this....my muni bonds are up almost 10% since last year, which is a significant increase. it might not be a great time to buy in. they are quite a bit more volatile that regular US bonds....similar to junk bonds, i guess.

If you are set on CA only, that's fine (check out PWZ but understand it holds PR bonds too). If you want more diversification and income, then look into PZA which is AMT-free (although obv will not get you out of CA taxes) but returns like 3.5%

AbbaZabba said:   Why not buy individual muni bonds?
 

  liquidity, simplicity, diversification.

caproperty said:   I had been stockpiling ~$500k cash for a downpayment on a multi-unit deal but it recently fell through. However, I'm still planning to deploy the cash 3-5 years out from now (maybe sooner if I find a good deal). 

Here's a quick summary:

  • Cash has been sitting in 1% savings accounts
  • Will be at the highest federal tax bracket (39.6%) for the next 2-3 years
  • Will be in the 11.3-12.3% CA income tax bracket for the next 2-3 years
  • Looking to deploy the cash into real estate in next 3-5 years
  • CA has no long term capital gains rate (all income is taxed the same)

I'm looking for better options than 1% accounts (close to ~0.5% after federal/CA taxes). I've been looking into VCAIX (Vanguard CA Intermediate Muni Bond Fund) and VCITX (Vanguard CA Long-term Muni Bond Fund) as a good place to park the money. It'll shield from both federal and state taxes while yielding much better than the non-tax advantaged 1% accounts. What's my downside here? Massive CA defaults if we head into a recession? Interest rate risk (the intermediate bond fund should mitigate this a bit)? Are there other avenues I should be investigating?

I'll be asking around my network for ideas and report back what I hear. 

  
You do realize price of bond fund can go down right?   So fund may have for example making up a number 5% yield .. but you can end up losing 7% in price/mkt value .. for net return of -2%.  That's essentially the downside - pricing risk.   When you look at bound, lowest risk is the short term bond (so less yield), next is  intermediate.    Looking at morning start, in about last ten years, it lost money twice - 2008, it was down 7% and 2013 it was down 2.5%.  Otherwise it had positive return raging from 1.5% - 11%.   

I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).
 

prozario said:   
I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).
 

  i more or less do this too. have chunks in BND, BSV, PZA, MUI and then all my various CEFs. blended return is north of 4% and more than half is tax-free.

prozario said:   
I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).

  
What would you recommend for CA short term? I'm not seeing anything on Vanguard. The only short-term one that looks legit is through PIMCO (PCDIX) but their fees are much higher than Vanguard. 

caproperty said:   
prozario said:   
I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).

  
What would you recommend for CA short term? I'm not seeing anything on Vanguard. The only short-term one that looks legit is through PIMCO (PCDIX ) but their fees are much higher than Vanguard. 

if you like CEFs there are like 20 couple here. no shorts though.

http://screen.morningstar.com/cef-quick-rank?cefanalysis=availab... 
 

I would explore a CD for 2-2.5% with a 5-10 year term and <= 6 months penalty. I don't know what they are now, but last year I got into Sallie Mae CDs with 2.4% (5 yrs) and 6 months penalty for early termination.

caproperty said:   
prozario said:   
I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).

  
What would you recommend for CA short term? I'm not seeing anything on Vanguard. The only short-term one that looks legit is through PIMCO (PCDIX ) but their fees are much higher than Vanguard. 

  

Sorry didn't realize vanguard doesn't have CA short term.   If you have a broker account where you can buy from any  fund family - noticed Fidelity has one: FCSTX  - seems decent/low fee.  Also note, short term is much less risk, so yield is less too .. around 1%-4% over last 10 years. But on flip side, looking at morning star, it never lost money since 2006.

 

prozario said:   
caproperty said:   
prozario said:   
I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).

  
What would you recommend for CA short term? I'm not seeing anything on Vanguard. The only short-term one that looks legit is through PIMCO (PCDIX ) but their fees are much higher than Vanguard. 

  

Sorry didn't realize vanguard doesn't have CA short term.   If you have a broker account where you can buy from any  fund family - noticed Fidelity has one: FCSTX  - seems decent/low fee.  Also note, short term is much less risk, so yield is less too .. around 1%-4% over last 10 years. But on flip side, looking at morning star, it never lost money since 2006.

 

  

Also .. i know you want to avoid CA state tax ... so CA muni fund are best choice.  I know that CA isn't that as great financially .. but i doubt they'll ever let that big state default, fed will always be there for them.  But still - with that much money, I would put some portion of it in another state or pick a US treasury fund.  You want to strike a balance between reducing tax (putting everything in CA funds)  vs. reducing risk (putting some of it in another state or fed fund).

prozario said:   
caproperty said:   I had been stockpiling ~$500k cash for a downpayment on a multi-unit deal but it recently fell through. However, I'm still planning to deploy the cash 3-5 years out from now (maybe sooner if I find a good deal). 

Here's a quick summary:

  • Cash has been sitting in 1% savings accounts
  • Will be at the highest federal tax bracket (39.6%) for the next 2-3 years
  • Will be in the 11.3-12.3% CA income tax bracket for the next 2-3 years
  • Looking to deploy the cash into real estate in next 3-5 years
  • CA has no long term capital gains rate (all income is taxed the same)

I'm looking for better options than 1% accounts (close to ~0.5% after federal/CA taxes). I've been looking into VCAIX (Vanguard CA Intermediate Muni Bond Fund) and VCITX (Vanguard CA Long-term Muni Bond Fund) as a good place to park the money. It'll shield from both federal and state taxes while yielding much better than the non-tax advantaged 1% accounts. What's my downside here? Massive CA defaults if we head into a recession? Interest rate risk (the intermediate bond fund should mitigate this a bit)? Are there other avenues I should be investigating?

I'll be asking around my network for ideas and report back what I hear. 

  
You do realize price of bond fund can go down right?   So fund may have for example making up a number 5% yield .. but you can end up losing 7% in price/mkt value .. for net return of -2%.  That's essentially the downside - pricing risk.   When you look at bound, lowest risk is the short term bond (so less yield), next is  intermediate.    Looking at morning start, in about last ten years, it lost money twice - 2008, it was down 7% and 2013 it was down 2.5%.  Otherwise it had positive return raging from 1.5% - 11%.   

I would not put all $500K into single fund .. put $100K-$200K in CA intermediate, and perhaps put some part of it in CA short term, and mix it up with US Treasury fund  or another state fund.. which you dont pay taxes at fed level (but you pay state tax).    Basically i would split into 3 or 4 funds - easy way to do would be to pick all of them from Vanguard.  Mix it up with term (some short, some int, some long term) and region (state, fed etc).

Those funds have a long history. Of course past performance is not indicative of future results, but look at the drawdowns over 3-5 year periods in the funds. Can you stomach them?

VCAIX: http://finance.yahoo.com/echarts?s=VCAIX+Interactive#{"range":"m...
There are many drawdowns, many of 5-8% within a short period of time. The drawdown from Feb. 1, 2004 - Nov. 1, 2008 (-11.1%) appears to be the largest on a monthly chart within a 5-year span. That will completely eat up the coupon payments and then some if you need to liquidate at an inopportune time.

Then look at the Jan. 1, 1987 - Sep. 1, 1987 period for VCITX: http://finance.yahoo.com/echarts?s=VCITX#{"range":"max","allowCh... A 16.5% decline within a year. It took over five years for the fund to recover, although you would have received coupon payments along the way.

I've been in muni-bond ETFs and maintain a portfolio of less than investment grade (BBB and lower) muni-bonds for many years and have/had your concerns. Here's the distilled muni-bond assessment as it pertains to your predicament of being one of "entitled" few, of which I am a member, that pay at highest marginal income tax rates at the Federal and state level. Currently keep the maturities under 8 years that should moderate the decline of portfolio should interest rates rise quickly, if rates rise slowly the concern is lessened. Be sure to select a liquid ETF otherwise the bid ask spread will be to your disadvantage. Provided the after tax rates are justified consider a non CA fund. Muni defaults even for the non investment grade are astonishing low when compare with other debt instruments - Google it. Here's a source for further evaluations www.etf.com . I am also a era investor in both FL and CA real estate and the advice here, based upon the premise that a real estate investment could be a long term holding (20+ yrs) if the purchase isn't correctly in sync to the market cycle, be thankful that deal failed and you have the patience to await the next RE downturn.

caproperty said:   I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.
http://reason.org/news/show/1014190.html

$583 billion estimated unfunded pension liabilities statewide.

OP, I was in same situation - I mean about 6 digit cash that I will not have any other use in next 1-2 years and am in 33% and 10.3% tax bracket. Invested 2/3rds in VCAIX, CMF and MUB. I believe VCAIX is the safest and CMF is the most volatile. They are all up (which is a good thing but now need to wait to invest remaining 1/3rd) but the volatility is some what more than past. My expectation is about 4% income (pretax) over next 2 years and little capital appreciation. Please post what
you find out and do.....

Thanks for all the responses! Currently leaning towards a 50/50 split between FCSTX (CA short term) and VCAIX (CA intermediate term).

FCSTX expense ratio is 0.48% (they don't have Advantage class for this fund), which is pretty high relative to 0.20% for VCAIX.

Fidelity also has a nice set of bonuses for transferring in $100k+ of non-retirement assets -- 50k on either Delta/American/United.

jayK said:   
caproperty said:   I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.
http://reason.org/news/show/1014190.html 

$583 billion estimated unfunded pension liabilities statewide.

  Most if not all muni bonds in California are secured by some form of tax such as property taxes, sales tax or an equivalent such as a utility fee for water, power, etc.  The only way these bonds are defaulted on is when the stream of revenue drys out similar to what happened in Stockton.  Property taxes dropped by half and therefore, there weren't enough to pay for these bonds.  Other bankruptcies I've seen didn't really impact bonds by that much.  

caproperty said:   Thanks for all the responses! Currently leaning towards a 50/50 split between FCSTX (CA short term) and VCAIX (CA intermediate term).

FCSTX expense ratio is 0.48% (they don't have Advantage class for this fund), which is pretty high relative to 0.20% for VCAIX.

Fidelity also has a nice set of bonuses for transferring in $100k+ of non-retirement assets -- 50k on either Delta/American/United.

  
You can go with that, and later if you feel the need, always change things - re-balance between the two, or even add more funds later on.  Mutual funds, especially bonds wont have big swings overnight - so you'll have time to react.  Getting signup bonus is very nice plus. 

ahmadcpa said:   
jayK said:   
caproperty said:   I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.
http://reason.org/news/show/1014190.html 

$583 billion estimated unfunded pension liabilities statewide.

  Most if not all muni bonds in California are secured by some form of tax such as property taxes, sales tax or an equivalent such as a utility fee for water, power, etc.  The only way these bonds are defaulted on is when the stream of revenue drys out similar to what happened in Stockton.  Property taxes dropped by half and therefore, there weren't enough to pay for these bonds.  Other bankruptcies I've seen didn't really impact bonds by that much.  

The issue is not revenue streams drying up, it's that current revenue streams are not enough to cover future unfunded liabilities. Pension obligations persist through muni BK so bondholders would have to settle for whatever is left over.

jayK said:   
ahmadcpa said:   
jayK said:   
caproperty said:   I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.
http://reason.org/news/show/1014190.html 

$583 billion estimated unfunded pension liabilities statewide.

  Most if not all muni bonds in California are secured by some form of tax such as property taxes, sales tax or an equivalent such as a utility fee for water, power, etc.  The only way these bonds are defaulted on is when the stream of revenue drys out similar to what happened in Stockton.  Property taxes dropped by half and therefore, there weren't enough to pay for these bonds.  Other bankruptcies I've seen didn't really impact bonds by that much.  

The issue is not revenue streams drying up, it's that current revenue streams are not enough to cover future unfunded liabilities. Pension obligations persist through muni BK so bondholders would have to settle for whatever is left over.

  
In terms of % of fully funded pension liabilities CA is ranked 21/50 (source), which is slightly better than average. I don't see how a nation-wide tax-exempt muni fund would be better as I assume their holdings are distributed across all 50 states.

Vanguard currently has state-specific muni bond funds for CA, MA, NJ, NY, OH and PA. Only NY (ranked 7/50) has a higher % of funded pension liabilities than CA. 

I could see someone saying muni funds in general are a bad idea, but I still don't understand how a CA muni fund would be any worse than any other state's (or nationwide) muni fund.

mailvips said:   OP, I was in same situation - I mean about 6 digit cash that I will not have any other use in next 1-2 years and am in 33% and 10.3% tax bracket. Invested 2/3rds in VCAIX, CMF and MUB.
 

  Not sure what 6 digit cash means in this case but you should have chosen VCADX (Admiral Shares) with lower ER if you invested $50K or more in that fund.

I would not invest in any bonds right now outside of short term US treasuries. I can assure you that in the next 12 months, you could see 20% of bonds implode, especially muni's. Run, don't walk.

you might do better a rated lending club notes

Powza said:   
mailvips said:   OP, I was in same situation - I mean about 6 digit cash that I will not have any other use in next 1-2 years and am in 33% and 10.3% tax bracket. Invested 2/3rds in VCAIX, CMF and MUB.
  Not sure what 6 digit cash means in this case but you should have chosen VCADX (Admiral Shares) with lower ER if you invested $50K or more in that fund.

  
VCADX (0.12%) really blows FCSTX (0.48%) out of the water. I'm tempted to weight it more on VCADX now.
mcgiffid said:   I would not invest in any bonds right now outside of short term US treasuries. I can assure you that in the next 12 months, you could see 20% of bonds implode, especially muni's. Run, don't walk.
  What makes you say that?
manuvns said:   you might do better a rated lending club notes
  Unfortunately, those would not be tax-exempt. I would need to have almost double the pre-tax return on LendingClub notes.

20% downturn on CA bond by a year. Let's just there is no credit issue - they wont run out of money in CA in a year. So basically .. interest rate swing large enough to cut down intermediate bond value by 20% in a year? I don't believe that has happened in last 20 years, and certainly wont happen in next 12 months.

Economy is too soft .. Int rates wont go up by that much.

jayK said:   
caproperty said:   I did some searching and only found this article that specifically calls out CA muni bond default risk. I've yet to find more articles that place CA muni bonds at a significantly higher risk than other states' muni bonds.
http://reason.org/news/show/1014190.html 

$583 billion estimated unfunded pension liabilities statewide.

  
That article actually says:
"Estimates peg California's unfunded pension liability between $130 billion on the low end and $583 billion on the high end"
 

I spoke with one of my friends who used to work as an analyst for a top-tier investment bank doing securitization of bonds — both corporate and municipal. She's no longer in investment banking and hated her time working in finance so I don't think she's biased for muni bonds in any way. 

Here's what she had to say...

  • Muni bond default risk is exceptionally low compared to similarly rated corporate bonds
  • CA is as big as several states so single state risk isn't as large as it is for smaller states (e.g. OH, NJ or MA)
  • She's not worried about underfunded pensions as many bonds are collateralized directly against tax measures
  • For diversification, it's more important to look at what types of muni bonds are held by the fund versus what state they are in

    • Make sure you have city, county and state-wide issues (usually general obligation bonds)
    • Make sure you have issues from utilities, transportation authorities, school boards, etc.. (usually revenue bonds)

  • Being in a high tax bracket for both state and federal it's hard to beat post-tax returns on muni bonds

When I asked her if there were any prominent naysayers in the muni bond world, she pointed to Meredith Whitney — who correctly called the 2008 crash. She predicted a muni bond crash in 2010/2011 which didn't materialize; other folks are saying it might take a few more years to actually come. There's a pretty good discussion on Quora about it. 

caproperty said:   
She's not worried about underfunded pensions as many bonds are collateralized directly against tax measures

That's assuming additional tax hikes are approved to cover pension liabilities.

brettdoyle said:   You're asking us if you should loan the money to a state with an out of control spending problem and up to their eyeballs in debt while you wait to invest in a housing bubble?
  
Hey, take it from someone coming from IL/Cook County, California State looks fiscally responsible!

I'm in a similar situation so I am curious what you finally decided, OP?

sfchris said:   I'm in a similar situation so I am curious what you finally decided, OP?

  • $480k in VCADX
  • $115k in CMF

I would've put it all in VCADX. VCADX seemed like the best mix of ROI, risk and low expenses. However, Fidelity was offering 50k AA/Delta/United miles for moving $100k+ into the account. 

CalPERS posted returns of 0.61% last year, the average return needed to stay solvent is 7.5% per year. This will lead to increased forced contributions from CA municipalities within the next couple years.
http://www.latimes.com/business/la-fi-calpers-returns-20160718-s...

jayK said:   CalPERS posted returns of 0.61% last year, the average return needed to stay solvent is 7.5% per year. This will lead to increased forced contributions from CA municipalities within the next couple years.
http://www.latimes.com/business/la-fi-calpers-returns-20160718-s...

  
Are you saying that you expect CA municipalities to default on their bonds because of CalPERS?

sfchris said:   
jayK said:   CalPERS posted returns of 0.61% last year, the average return needed to stay solvent is 7.5% per year. This will lead to increased forced contributions from CA municipalities within the next couple years.
http://www.latimes.com/business/la-fi-calpers-returns-20160718-s...

  
Are you saying that you expect CA municipalities to default on their bonds because of CalPERS?

Yes, municipalities who don't address the unfunded pension liability issue are more likely to default. The pension debt load continues to get worse and if it's not paid down aggressively it will eventually reach a point where municipalities won't be able to reduce municipal expenses enough to cover it.



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