Vanguard: High-Yield and Tax-Exempt

11/16/2017 5:00 am EST

Focus: BONDS

John Persinos

Managing Editor, Personal Finance

The Vanguard High-Yield Tax-Exempt Fund (VWAHX) seeks a high and sustainable level of income that’s exempt from federal personal income taxes. The fund invests at least 80% of its assets in investment-grade municipal bonds, notes John Persinos, editor Personal Finance.

Municipal bonds, aka “munis,” are IOU’s issued by city, county, and state governments to raise funds for community projects such as highways, schools, firehouses, or hospitals.

Their chief appeal is that the interest paid to the owner of a municipal bond is exempt from federal taxes. Typically, an investor is also exempt from state taxes if he lives in the same state in which the municipal bonds were issued. What’s more, tax-exempt bonds help diversify a portfolio of stocks and taxable bonds.

Among the tax proposals now being floated in Washington DC, there are many major tax cuts and breaks for corporations and the super wealthy, but nothing for average investors.

You should take pro-active action and look for tax-sheltered vehicles that will likely survive the tax machinations on Capitol Hill. Municipal bond funds fit the bill, especially VWAHX.


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VWAHX’s portfolio is graced by mostly top-rated municipal bonds; the most recent semi-annual report for VWAHX shows only 0.4% of the fund’s assets in bonds issued by Puerto Rico.

Autumn is the time to start planning your taxes. Profitable investors will be looking at their 1040s and noticing that their healthy gains during this bull market also mean a bigger wad of money is going to the IRS. Which is why you should consider municipal bonds.

Municipal bonds have performed well in light of existing market conditions. With all the uncertainty in the stock market lately, you should be looking for steady, dividend-paying investments to bring ballast to their portfolio, which is exactly what the right bonds can provide.

By investing in a basket of municipal bonds via VWAHX, market volatility is less likely to wreak havoc on your portfolio.

Also consider Federal Reserve policy, which is getting more hawkish. Rising rates translate into higher government bond yields, which makes the risk/reward ratio for dividend-paying stocks less attractive to investors.

But high-income choices still exist, if you know where to look. Several interrelated trends are making municipal bonds look better and better.

Economic growth on the federal and state levels should continue into 2018, providing a tailwind for the fund. Meanwhile, an increasing number of states have maintained or secured improved credit ratings, prompting most analysts to issue generally upbeat assessments about the credit quality of U.S. states.

Nationally, total state tax revenue has recovered from its plunge during the Great Recession. By all major metrics — revenue, spending, economy, long-term costs, and fiscal policy — the “state of the states” is good. Another tailwind for VWAHX is the growing demand for infrastructure repair in the U.S.

All of these long-term trends bode well for VWAHX. With net assets of $12.2 billion, the fund has generated a healthy year-to-date total return of 6.2% and throws of a current dividend yield of 3.69%.

Morningstar gives the fund a rating of five stars; the minimum initial investment is $3,000. Vanguard High-Yield Tax-Exempt Fund is a compelling high-yield choice that belongs in your dividend portfolio.

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