Subject: Deriving SEC-yield relationships in inverted interest-rate years, for Vanguard bond types in normal interest-rate years.
In a recent topic, OP was wondering what to do with additional income after contributing to their stock-heavy retirement plans. They also have a stock-heavy Vanguard taxable account, no bonds.
I explained how I’d solved this problem for my tax situation by creating sample tax returns to wag the after-tax income produced by the different bond types (ST/IT/LT, treasury/muni/TBM/corporate). My answer: LT national muni fund (VWLTX) was expected to produce the most after-tax income.
OP thought this a good idea.
But! We’re in an inverted-yield interest-rate environment, so ST-IT yields/dividends are higher than normal, so sample tax returns based on current SEC yields may produce suboptimal results when yields/dividends revert to normal. What to do?
In a later reply to OP, I tried to derive* what I thought was the relationship among the bond types---their ability to produce dividends---during normal interest-rate years. I thought my approach was logical, but would value the BHs’ second opinions.
* How I derived the relationships among bond types, see reply: viewtopic.php?p=7925596#p7925596
Update, to make this a standalone topic, the first reply below is what I posted for OP (above link).
I identified what I believed to be the ability of each bond type to produce normal-year dividends, to be a percentage (LT%) of LT corporate’s SEC yield. From my limited bond-investor experience, I assumed LT corporate’s SEC yield/dividends to be the highest during normal interest-rate years, with other* bond types’ yields trailing based on the market’s perception of each’s reward/risk (normal-year SEC yields). So as yields rise/fall across durations/time, if I start with LT corporate's SEC yield now, then I can wag the expected SEC yield of the other bond types during normal interest-rate years; which means I can wag the dividends produces by each; so can create representative sample tax returns for each. (* Recall recommended bond books advised ignoring HY bonds, so I did: when I created my sample tax returns, and now.)
These are the relationships which I believe exist among the bond types (vs LT corporate) in normal interest-rate years.
Bond type: LT%.
--LT Corporate (VLTCX): 100%.
--LT muni (VWLUX): 89%.
--IT corporate (VICSX): 79%.
--IT muni (VWIUX): 68%.
--TBM (VBTLX): 62%.
--LT treasury (VLGSX): 61%.
--IT treasury (VFIUX): 53%.
--ST treasury (VFSUX): 51%.
--ST corporate (VSCSX): 51%.
--Muni index (VTEAX): 40%.
--Limited-term muni (VMLUX): 39%.
--ST muni (VWSUX): 25%.
How is LT% used?
Assume we want to produce sample tax returns to evaluate which bond type is expected to produce the most after-tax income, but we’re in an inverted-yield interest-rate environment, so current SEC yields are suspect, meaning dividends wagged from those SEC yields are also suspect. What to do?
--Lookup LT corporate’s current SEC yield.
--By bond type, wag: expected normal-year dividends = bond type’s LT% x LT corporate's SEC yield x bond principal.
--By bond type, use dividends to create sample tax returns, to wag: after-tax income = fed taxable income +TE dividends -fed tax owed -state tax owed.
Example. What are the steps to determine which bond type is expected to produce the most after-tax income for our tax situation: now, and after yields revert to normal. Assume $100K bond principal and current inverted yields.
1. Wag dividend inputs to create sample tax returns for each bond type.
Current inverted SEC yields/dividends for sample tax return:
--LT corporate (VLTCX): 5.74%; see: https://investor.vanguard.com/investmen ... file/vltcx ; expected dividends: $5740 (=5.74% x 100K).
--LT muni (VWLUX): 3.84%; see: https://investor.vanguard.com/investmen ... file/vwlux ; expected dividends: $3840 (=3.84% x 100K).
--LT treasury (VLGSX: 4.65%; see: https://investor.vanguard.com/investmen ... file/vlgsx ; expected dividends: $4650 (=4.65% x 100K).
--IT treasury (VFIUX): 4.33% ; see: https://investor.vanguard.com/investmen ... file/vfiux ; expected dividends: $4300 (=4.33% x 100K).
--ST treasury (VFSUX): 5.10%; see: https://investor.vanguard.com/investmen ... file/vfsux ; expected dividends: $5100 (=5.10% x 100K).
Expected normal-year SEC yields/dividends for sample tax return:
--LT corporate (VLTCX): 5.74% (=100% x 5.74%); expected dividends: $5740 (=5.74% x 100K).
--LT muni (VWLUX): 5.11% (=89% x 5.74%); expected dividends: $5110 (=5.11% x 100K).
--LT treasury (VLGSX: 3.50% (=61% x 5.74%); expected dividends: $3500 (=3.50% x 100K).
--IT treasury (VFIUX): 3.04% (=53% x 5.74%); expected dividends: $3040 (=3.04% x 100K).
--ST treasury (VFSUX): 2.93% (=51% x 5.74%); expected dividends: $2930 (=2.93% x 100K).
2. Create sample tax returns for each bond type and calculate after-tax income for each.
Pro tip. To keep yourself straight, generate all bond inputs and collect all results on an Excel sheet. Use one sheet for each: normal years, inverted years.
3. Analyze results.
--If you find a bond type that’s expected to do well during normal years, and also during current inverted years, then that’s a win^2.
--If close to SS, repeat tax-return exercises with expected SS benefit, to try to identify a bond type which might produce a win^4.
Simplifying assumptions.
--While normal year expected/actual dividends may not match, the ranking of each bond types’ ability to produce dividends should hold (vs LT corporate).
--Tax s/w handles all our tax-code issues (benefits phase-outs, tax phase-ins), except: ACA credit and IRMAA.
--Prioritize the selection of bond type(s) expected to do well during normal years, because more normal years are expected than inverted.
--Don’t be too greedy; leave 10% for the other guy. This is to avoid CG tax loss from whipsawing investments to chase yields, and to keep your life simple.
My math skills are limited to balancing my checkbook (most months), so can't take this idea further, nor do I understand how it may be flawed.
If you find this idea to be of value and want to play with it, then you have my blessing to do so.
OP has replied that they are not interested in creating multiple sample tax returns, so will not use this idea.
I don’t believe OP will go too far wrong with LT muni, even if they don’t create sample tax returns for all bond types. Why?
--OP can tolerate risk (high current allocation to stocks), currently in 24% fed tax bracket, and interested in more after-tax income.
--LT muni’s LT% (89%) is highest of all non-LT-corporate bond types, so wag OP will earn ~17% (=(.89/(1-.24))-1) more after-tax vs LT corporate.
--In current inverted-yield environment, it produces more after-tax than TBM (standard I try to beat) in my 22% fed tax bracket; assume it will also for OP.
I spent June tweaking this idea ...as a work-in-progress then ...so I could ask for your comments now.
I believed this idea may have merit, but unsure how much, so I'd like to know the opinion of BHs who are more versed in investing theory.
In a recent topic, OP was wondering what to do with additional income after contributing to their stock-heavy retirement plans. They also have a stock-heavy Vanguard taxable account, no bonds.
I explained how I’d solved this problem for my tax situation by creating sample tax returns to wag the after-tax income produced by the different bond types (ST/IT/LT, treasury/muni/TBM/corporate). My answer: LT national muni fund (VWLTX) was expected to produce the most after-tax income.
OP thought this a good idea.
But! We’re in an inverted-yield interest-rate environment, so ST-IT yields/dividends are higher than normal, so sample tax returns based on current SEC yields may produce suboptimal results when yields/dividends revert to normal. What to do?
In a later reply to OP, I tried to derive* what I thought was the relationship among the bond types---their ability to produce dividends---during normal interest-rate years. I thought my approach was logical, but would value the BHs’ second opinions.
* How I derived the relationships among bond types, see reply: viewtopic.php?p=7925596#p7925596
Update, to make this a standalone topic, the first reply below is what I posted for OP (above link).
I identified what I believed to be the ability of each bond type to produce normal-year dividends, to be a percentage (LT%) of LT corporate’s SEC yield. From my limited bond-investor experience, I assumed LT corporate’s SEC yield/dividends to be the highest during normal interest-rate years, with other* bond types’ yields trailing based on the market’s perception of each’s reward/risk (normal-year SEC yields). So as yields rise/fall across durations/time, if I start with LT corporate's SEC yield now, then I can wag the expected SEC yield of the other bond types during normal interest-rate years; which means I can wag the dividends produces by each; so can create representative sample tax returns for each. (* Recall recommended bond books advised ignoring HY bonds, so I did: when I created my sample tax returns, and now.)
These are the relationships which I believe exist among the bond types (vs LT corporate) in normal interest-rate years.
Bond type: LT%.
--LT Corporate (VLTCX): 100%.
--LT muni (VWLUX): 89%.
--IT corporate (VICSX): 79%.
--IT muni (VWIUX): 68%.
--TBM (VBTLX): 62%.
--LT treasury (VLGSX): 61%.
--IT treasury (VFIUX): 53%.
--ST treasury (VFSUX): 51%.
--ST corporate (VSCSX): 51%.
--Muni index (VTEAX): 40%.
--Limited-term muni (VMLUX): 39%.
--ST muni (VWSUX): 25%.
How is LT% used?
Assume we want to produce sample tax returns to evaluate which bond type is expected to produce the most after-tax income, but we’re in an inverted-yield interest-rate environment, so current SEC yields are suspect, meaning dividends wagged from those SEC yields are also suspect. What to do?
--Lookup LT corporate’s current SEC yield.
--By bond type, wag: expected normal-year dividends = bond type’s LT% x LT corporate's SEC yield x bond principal.
--By bond type, use dividends to create sample tax returns, to wag: after-tax income = fed taxable income +TE dividends -fed tax owed -state tax owed.
Example. What are the steps to determine which bond type is expected to produce the most after-tax income for our tax situation: now, and after yields revert to normal. Assume $100K bond principal and current inverted yields.
1. Wag dividend inputs to create sample tax returns for each bond type.
Current inverted SEC yields/dividends for sample tax return:
--LT corporate (VLTCX): 5.74%; see: https://investor.vanguard.com/investmen ... file/vltcx ; expected dividends: $5740 (=5.74% x 100K).
--LT muni (VWLUX): 3.84%; see: https://investor.vanguard.com/investmen ... file/vwlux ; expected dividends: $3840 (=3.84% x 100K).
--LT treasury (VLGSX: 4.65%; see: https://investor.vanguard.com/investmen ... file/vlgsx ; expected dividends: $4650 (=4.65% x 100K).
--IT treasury (VFIUX): 4.33% ; see: https://investor.vanguard.com/investmen ... file/vfiux ; expected dividends: $4300 (=4.33% x 100K).
--ST treasury (VFSUX): 5.10%; see: https://investor.vanguard.com/investmen ... file/vfsux ; expected dividends: $5100 (=5.10% x 100K).
Expected normal-year SEC yields/dividends for sample tax return:
--LT corporate (VLTCX): 5.74% (=100% x 5.74%); expected dividends: $5740 (=5.74% x 100K).
--LT muni (VWLUX): 5.11% (=89% x 5.74%); expected dividends: $5110 (=5.11% x 100K).
--LT treasury (VLGSX: 3.50% (=61% x 5.74%); expected dividends: $3500 (=3.50% x 100K).
--IT treasury (VFIUX): 3.04% (=53% x 5.74%); expected dividends: $3040 (=3.04% x 100K).
--ST treasury (VFSUX): 2.93% (=51% x 5.74%); expected dividends: $2930 (=2.93% x 100K).
2. Create sample tax returns for each bond type and calculate after-tax income for each.
Pro tip. To keep yourself straight, generate all bond inputs and collect all results on an Excel sheet. Use one sheet for each: normal years, inverted years.
3. Analyze results.
--If you find a bond type that’s expected to do well during normal years, and also during current inverted years, then that’s a win^2.
--If close to SS, repeat tax-return exercises with expected SS benefit, to try to identify a bond type which might produce a win^4.
Simplifying assumptions.
--While normal year expected/actual dividends may not match, the ranking of each bond types’ ability to produce dividends should hold (vs LT corporate).
--Tax s/w handles all our tax-code issues (benefits phase-outs, tax phase-ins), except: ACA credit and IRMAA.
--Prioritize the selection of bond type(s) expected to do well during normal years, because more normal years are expected than inverted.
--Don’t be too greedy; leave 10% for the other guy. This is to avoid CG tax loss from whipsawing investments to chase yields, and to keep your life simple.
My math skills are limited to balancing my checkbook (most months), so can't take this idea further, nor do I understand how it may be flawed.
If you find this idea to be of value and want to play with it, then you have my blessing to do so.
OP has replied that they are not interested in creating multiple sample tax returns, so will not use this idea.
I don’t believe OP will go too far wrong with LT muni, even if they don’t create sample tax returns for all bond types. Why?
--OP can tolerate risk (high current allocation to stocks), currently in 24% fed tax bracket, and interested in more after-tax income.
--LT muni’s LT% (89%) is highest of all non-LT-corporate bond types, so wag OP will earn ~17% (=(.89/(1-.24))-1) more after-tax vs LT corporate.
--In current inverted-yield environment, it produces more after-tax than TBM (standard I try to beat) in my 22% fed tax bracket; assume it will also for OP.
I spent June tweaking this idea ...as a work-in-progress then ...so I could ask for your comments now.
I believed this idea may have merit, but unsure how much, so I'd like to know the opinion of BHs who are more versed in investing theory.
Statistics: Posted by dratkinson — Fri Jul 19, 2024 4:21 pm — Replies 1 — Views 166