Investors focused on tax-free income have two new options from Vanguard to consider as Vanguard’s asset management company launches a municipal bond exchange-traded fund (ETF). The Intermediate-Term Tax-Exempt Bond ETF (VTEI) and the California Tax-Exempt Bond ETF (VTEC) debuted last week, giving investors access to a key part of the municipal bond yield curve, spots that see price increases during federal policy decisions. became. Reserves dial back interest rates. Bond prices and yields are inversely proportional to each other. “If we still see relatively low default rates, high credit quality, and investors are willing to move a little further down the curve into intermediate and perhaps long-term strategies, they will be looking for more yield there,” he said. Probably.” Beth Foods, Morningstar Associate Director and Research Manager. Tax Advantages The biggest selling point of municipal bond funds is that they provide tax-free income. At the federal level, municipal bond income is not subject to income taxes, but investors can also avoid state taxes on this income if they reside in the state where the bond is issued. The savings could be significant for Californians, who could face a top marginal income tax rate of 14.4%, and New Yorkers, who face a top tax rate of 10.9%. For high-income investors, there’s also the issue of tax-equivalent yield, or the yield you would have to generate on a taxable bond to earn the same amount of income on a tax-exempt bond. According to New York Life Investments, someone in the 32% federal income tax bracket receiving a 3% tax-free yield on a municipal bond would need to look for a taxable bond with a 4.41% yield to earn the same income. That’s what it means. . The life of the bond is also an important consideration for local investors. Higher Federal Reserve rates and an inverted yield curve have made short-term fixed-income investments, such as certificates of deposit and money market funds, especially those with yields above 5%, attractive. Strategists recommend adding long-term bonds with higher duration, or price sensitivity to changes in interest rates, to reduce reinvestment risk after interest rates fall and benefit from rising prices. In fact, VTEI has a duration of about four years, while California-focused VTEC has a duration of about five years, said Jeffrey Johnson, Vanguard’s head of U.S. fixed income products. What’s notable about VTEI and VTEC is that both funds use an index-based approach, which Johnson says is a growing trend within the Muni market. VTEC is based on the S&P California AMT-Free Municipal Bond Index and VTEI is based on the S&P Medium-Term National AMT-Free Municipal Bond Index. This approach not only lowers your fees, but also allows you to earn more. Both ETFs have an expense ratio of 0.08%. Flow Trends Investors in intermediate-term municipal bond funds caught a splash in 2022 as the Fed raised interest rates and bond prices fell. In the same year, Vanguard Intermediate Tax Exempt Fund (VWITX) had a total return of -6.91%, but rebounded to increase by 5.82% in 2023. Funds are also returning to medium-term local government funds. Investors withdrew more than $520 million from these funds in October 2023 as bond yields soared and the 10-year Treasury rate reached 5%, according to Morningstar Direct. But $2.8 billion in assets flowed into intermediate-term municipal bond funds in November, and another $2.3 billion in December, according to Morningstar research. The question is whether investors who have been raising cash will be more likely to add exposure to bonds to diversify their bond holdings. Indeed, the Fed has indicated that a rate cut in March is unlikely, so yields on cash-like investments may remain attractive for some time. “If you had money on the side, when would you want to jump in there?” said Mr. Foos of the municipal bond fund. “It remains a solid choice due to its low default rate, tax benefits, and stability that long-term investors can appreciate.”
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