Short Term Tax Exempt Bonds

Altruist Financial Advisors LLC
Fee-Only Financial Planning and Portfolio Management

Short Term Tax Exempt Bonds are municipal bonds of short duration. Their coupon payments are exempt from federal taxation (unless they are AMT preference bonds and you are subject to the AMT). Short Term Tax Exempt bonds have investment characteristics similar to those of taxable short-term bonds. It may be appropriate to use them if there isn't room for taxable bonds in your tax-deferred/tax-exempt accounts.

There are several very similar investment options available. Which is best?

All of the options discussed here will likely have very similar performance and will get the job done quite well. You can't go far wrong choosing any of the options listed here. The funds are listed in rough overall order of preference.

It is imprudent to use municipal bonds in retirement accounts. So we only list preferences for taxable accounts. For retirement accounts consider Short-Term Taxable Bonds.

For a listing of our preferences in other asset classes, see here.

Taxable Accounts

	Vanguard Limited-Term Tax-Exempt Fund Admiral Shares (VMLUX). E/R: 0.12%. Minimum initial investment = $50,000. Invests in short-term muni bonds.
	Vanguard Limited-Term Tax-Exempt Fund (VMLTX). E/R: 0.20%. Invests in short-term muni bonds.
	SPDR Nuveen Barclays Short-Term Municipal Bond ETF (SHM). E/R: 0.20%. This ETF tracks the Barclays US Short-Term Municipal Bond Index. This fund eschews AMT preference bonds. For more information on ETFs, see here. We prefer SHM over SMB principally because the fund has dramatically more assets, which should give better liquidity.
	Market Vectors Short Municipal Index ETF (SMB). E/R: 0.20%. This ETF tracks the Barclays US AMT-Free Short Continuous Municipal Index. This fund eschews AMT preference bonds. For more information on ETFs, see here.
	DFA Short-Term Municipal Bond Portfolio (DFSMX). E/R: 0.23%. This fund eschews AMT preference bonds. This fund's "variable maturity" strategy should enhance its risk/return characteristics somewhat. However, because of the illiquidity of municipal bonds, they only implement the variable maturity strategy with new money. This limits the benefits which the strategy can deliver. As of 2/28/2007, the DFA fund had none of its investments in AMT preference bonds, while VMLTX had 1.9% of its dividends from AMT preference bonds. The DFA fund is intending to change its prospectus to prohibit any further investments in AMT preference bonds. So, for investors who are subject to the AMT, the DFA fund becomes slightly more attractive. The DFA fund would also become increasingly attractive to those subject to AMT as interest rates increase.
	iShares S&P Short Term National Municipal Bond Fund (SUB). E/R: 0.25%. This ETF tracks the S&P National 0-5 Year Municipal Bond Index. This fund eschews AMT preference bonds. For more information on ETFs, see here.
	Vanguard Short-Term Tax-Exempt Fund (VWSTX). E/R: 0.20%. This fund has an extremely short duration (i.e., about half that of VMLTX). If you live in a high-tax state and are separately attracted to medium to long-term tax-exempt state-specific bond funds, you can lessen the overall effective duration by combining that fund with this one.
	PIMCO Short-Duration Muni Income Fund Institutional Shares (PSDIX). E/R: 0.35%. We see no reason to buy this fund when the above less costly alternatives exist.

This web page contains the current opinions of Eric E. Haas at the time it is written — and such opinions are subject to change without notice. This web page is for educational purposes only — we believe the information provided here to be useful and accurate at the time it is written. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

No investor should invest solely on the basis of information listed here. Before investing, it is important to consult each prospective investment's prospectus and consider both its risk/return characteristics and its effect on your overall portfolio.

This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Altruist recommends consultation with a qualified tax adviser, CPA, financial planner, or investment adviser. If you would like to discuss the rationale or support for any particular idea expressed on this web page, feel free to contact us.

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