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 is 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.
 | Vanguard Limited-Term Tax-Exempt Fund (VMLTX). E/R: 0.20%.
If you have greater than $100,000 to invest, the Admiral Shares of this fund (VMLUX)
are very hard to beat, with an expense ratio of 0.12%.
|
| SPDR 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.
|
| DFA Short-Term Municipal Bond Portfolio (DFSMX). E/R: 0.25%.
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.
|
| Market Vectors Short Municipal Index ETF (SMB). E/R: 0.16%.
This ETF tracks the Barclays US AMT-Free Short Continuous Municipal Index. This fund eschews AMT
preference bonds. This fund is extremely new (2/22/08). We
recommend waiting until this fund gets more assets before buying it.
Unless it gets enough assets quickly enough, its expense ratio may go up (to
0.65%!) after 4/30/2008. 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. |
