Three Vanguard Muni Bond Buys

12/09/2008 1:00 pm EST

Focus: BONDS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Dan Wiener, editor of The Independent Adviser for Vanguard Investors, says this is a good time to buy municipals, and he recommends three favorites.

The long bull market in bonds, which was interrupted for a brief period during the stock market's recovery from the 2000-2002 bear market, is back on track as yields on Treasuries have fallen, in many cases, to record lows.

But as Treasury prices have been rising on investor panic and a flight to safety, corporate and tax-exempt bonds have been lagging—big-time. Investors who are both tax-averse and looking for some opportunities may find the current yields on Vanguard's family of tax-free funds enticing, from money market funds to long bond funds.

Typically Vanguard's funds hold a very diverse array of bonds from myriad states. Diversification is part of what makes these funds appealing. Vanguard managers don't stick their necks out. So, funds are run conservatively. On average, over the past ten years, it's been pretty tough to lose money in a tax-exempt bond fund.

Now here's a quick rundown on Vanguard's choices:

Vanguard Short-Term Tax-Exempt (VWSTX) Buy. Investors should think of this fund as a money market fund on steroids. VWSTX’s yield is pumped by pushing average maturity and duration to a bit more than one year. So, unlike a money market fund, Short-Term's price will fluctuate. And so will returns. If you have more than a year's worth of spending money sitting in a money market, you might want to take some of that excess and invest it here.

Still, if you choose to put the bulk of your cash here, you should also keep a money market fund for your check-writing needs. Every check written on VWSTX results in a taxable transaction.

Vanguard Limited-Term Tax-Exempt (VMLTX). Buy. This is the fund to compare to the short-term taxables, though its risk profile would be higher than that of the corporate bond fund. Duration, a measure of interest rate risk, at 2.4 years, is a bit longer on this fund than on the short-term taxables and a hair less than that of Short-Term Bond Index, but risk is still very limited. Why do you think Vanguard founder Jack Bogle has, in the past, stashed more than $3 million of his own money here?

Intermediate-Term Tax-Exempt (VWITX). Buy. The middle of the yield curve—the line that plots yields against maturities—is where fixed-income investors often get the biggest bang for their bucks while taking the least relative risk.

Over long periods of time, this is a great fund. On average, over rolling one-, three-, and five-year periods, this fund's returns have equaled almost 80% of the returns on Vanguard's taxable intermediate funds. That makes it a pretty good bet for investors in all but the lowest tax brackets. A quick hike in yields might hurt returns over the short haul. But this can be a good fund for those who want higher levels of current income but are willing to take some risk with their principal.

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