Tax Exempt Money Market vs. Bond Fund

Bonds will do better on average than money market funds, because of the added risk. The added risk is that a bond fund share price can go up or down. A money market investment won't. Short-term bond funds won't have as much interest rate risk as the longer-term bond funds, so you could park emergency funds in a good short-term bond fund, but a money market is more liquid and safer. Make sure you don't escalate your spending to match your new income, until you've institutionalized a process of salting away a good chunk of it in IRAs and 401ks etc.

Money market is federal bonds or bank CDs less than 90 days . Other bond funds can be federal long term, state, city (tax advantaged), blue-chip corporations, shakey companies (highest return & risk), etc. You have to read prospectus of each for investment strategy, risk and return. Most prospectii are online.

Your initiall guess is right. The longer the duration of the bond holdings, the more interest risk you take. It is possible for your investment in USVAX to lose principal. But it also means you should be getting higher yields since longer term bonds will gnerally pay more than shorter term ones.

The goal is the highest after-tax return so what you should do is pick the highest return MMFs/Bond Funds (which are usually the lowest- expense ones) in all the tax categories. One those numbers in hand, you can run the numbers for what produces the biggest bang. I'll do a quickie example for MMFs.

Fully Taxable: Vanguard Prime MMF = 5.13% State Tax Exempt: Vanguard Treasury MMF = 4.80% Federal Tax Exempt: Vanguard Tax-Exempt MMF = 3.72% Fully Tax Exempt: USAA VA MMF = 3.35%

Then we have this nifty online calculator where you enter the yields for the 4 different categories to backtrack to pre-tax equivalents. Entering 28% Federal, 5.75% VA, itemizing, no AMT splits out:

Fully Taxable: 3.481% after tax, 5.130% tax equivalent Treasury: 3.456% after tax, 5.093% tax equivalent Nat'l Tax-Exempt: 3.566% after tax, 5.255% tax equivalent State Tax-Exempt: 3.350% after tax, 4.937% tax equivalent

So it looks paying state tax on 3.72% is the best option for this scenario.

Then you have to decide to whether you can risk losing 10% if interest rates increase. If so, then you run through the same above exercise for short term, medium term and long term bonds.

Your initiall guess is right. The longer the duration of the bond holdings, the more interest risk you take. It is possible for your investment in USVAX to lose principal. But it also means you should be getting higher yields longer term bonds will gnerally pay more than shorter term ones.

The goal is the highest after-tax return so what you should do is pick the highest return MMFs/Bond Funds (which are usually the lowest- expense ones) in all the tax categories. One those numbers in hand, you can run the numbers for what produces the biggest bang. I'll do a quickie example for MMFs.

Fully Taxable: Vanguard Prime MMF = 5.13% State Tax Exempt: Vanguard Treasury MMF = 4.80% Federal Tax Exempt: Vanguard Tax-Exempt MMF = 3.72% Fully Tax Exempt: USAA VA MMF = 3.35%

Then we have this nifty online calculator where you enter the yields for the 4 different categories to backtrack to pre-tax equivalents. Entering 28% Federal, 5.75% VA, itemizing, no AMT splits out:

Fully Taxable: 3.481% after tax, 5.130% tax equivalent Treasury: 3.456% after tax, 5.093% tax equivalent Nat'l Tax-Exempt: 3.566% after tax, 5.255% tax equivalent State Tax-Exempt: 3.350% after tax, 4.937% tax equivalent

So it looks paying state tax on 3.72% produces the best option.

Your initiall guess is right. The longer the duration of the bond holdings, the more interest risk you take. It is possible for your investment in USVAX to lose principal. But it also means you should be getting higher yields longer term bonds will gnerally pay more than shorter term ones.

The goal is the highest after-tax return so what you should do is pick the highest return MMFs/Bond Funds (which are usually the lowest- expense ones) in all the tax categories. One those numbers in hand, you can run the numbers for what produces the biggest bang. I'll do a quickie example for MMFs.

Fully Taxable: Vanguard Prime MMF = 5.13% State Tax Exempt: Vanguard Treasury MMF = 4.80% Federal Tax Exempt: Vanguard Tax-Exempt MMF = 3.72% Fully Tax Exempt: USAA VA MMF = 3.35%

Then we have this nifty online calculator where you enter the yields for the 4 different categories to backtrack to pre-tax equivalents. Entering 28% Federal, 5.75% VA, itemizing, no AMT splits out:

Fully Taxable: 3.481% after tax, 5.130% tax equivalent Treasury: 3.456% after tax, 5.093% tax equivalent Nat'l Tax-Exempt: 3.566% after tax, 5.255% tax equivalent State Tax-Exempt: 3.350% after tax, 4.937% tax equivalent

So it looks paying state tax on 3.72% produces the best option.

One should keep in mind that the prices for Tax Exempts are set by those investors with the most to benefit. If you in the 28% marginal bracket buying Muni bonds where prices are set by 39% investors, your paying too much.

If the amount on Form 1040, line 39, is: Over ---

$0 $42,350 ....... 15% $42,350 $102,300 $6,352.50 28%

$102,300 $155,950 $23,138.50 31%

$155,950 $278,450 $39,770.00 36%

$278,450 $83,870.00 39.6%