Tax Exempt Portfolio How to Gain Compound Dividends and Beat the Stock Market Chip Evans, PH.D & Dziko Thunde We’ve been studying and trading the stock market, bonds and stock options for over 40 years, and our website www.bluechipoptions.com specializes in educating the stock trader. Part of what we teach is using Fear and Greed and Supply and Demand and how to trade, and more, how to understand yourself.
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Tax Exempt Portfolio How to Gain Compound Dividends and Beat the Stock Market
Chip Evans, PH.D & Dziko Thunde
We’ve been studying and trading the stock market, bonds and stock options for over 40 years, and our website www.bluechipoptions.com specializes in educating the stock trader. Part of what we teach is using Fear and Greed and Supply and Demand and how to trade, and more, how to understand yourself.
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This is written in May 2015 and the market has seen the following returns over the past 52 weeks, not including any dividends paid.
We know that strong returns, such as the market has shown this past year, are not consistent, and also work with clients that wish
good returns that do not have tax consequences for selling, such as in non-retirement or 401K folios. Thus, we invest prudently in
all accounts and look for consistent and safe growth, and try to avoid “bubble” stocks.
We buy dividend stocks, the old formula, and look for any stock that has paid 3.5% to 12% dividend for at least 12 years or more,
and we buy them equal weighted average in a folio. We then hold and use a 25% trailing stop loss on our folio, OR we continue to
buy on any downturns, thusly lower our averaged cost while the dividend stays the same. Compounding is the key. Below is an
illustration of a comparison of an investment of $20,000 into a portfolio made up of Vanguard’s VWAHX and VWITX, compounded
for 4 ¼ years. Note, this portfolio shown below is for non-retirement investing and is federally tax exempt. This is where we keep
“safe money”, earning more than in a money market fund, or short term Certificate of Deposit.
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The table below shows what would happen if an investor starts with an initial investment of $20,000 into a portfolio made up of
Vanguards VWAHX and VWITX and then he adds $2,500 to VWAHX every year for 4 years. If we calculate the total yield per $10,000
invested, $20,000 above gives us $2,803.50 per $10,000 invested while $30,000 in table below gives us $2,229.67 per $10,000
invested in the 4 ¼ years.
Equal weighted average is the weighting assigned to each component of the average. For example, an investor wants to invest
$25,000 into a portfolio of five bonds with equal weighted average. This will mean that they will have to invest $5,000 in bond. This
example can be illustrated as follows:
The total investment of $25,000 into 5 bonds averages $5,000, which is equally weighted at 20% to spread the
risk of the investment.
If trading in a 401K, SEP or IRA, the concept of dividend stocks compounding is even more compelling, but not using TAX EXEMPT
folios or Treasuries.
But what if you were paying high income taxes, say the 28% bracket, and had the earning of stocks be far less than the % increase
overall, because of the tax burden.
Here’s what the returns would be for the same indices above, if the same conditions occurred.
We think simple. For some investors, the buy and hold theory of old has failed, as they expect high returns. In reality, a return of 10
to 12% in the stock market is doing great, and only those willing to take much higher risk for what “great returns” often get taxed
down to far less.
For the prudent trader looking for safety, low expense ratio, and “no work” we have created a simple folio of Vanguard bond funds.
You simply buy and hold and reinvest on any downside, or use a trailing stop loss if even more prudent.
Here is what we use, and why.
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Vanguard High-Yield Tax-Exempt VWAHX
The fund focuses on generating income with a stake in mid- and low-quality muni bonds that is heftier than what is found in the
typical intermediate-term muni-bond fund, but still takes on a much lower level of credit risk than the average fund in Morningstar's
high-yield muni category. And with duration of 6.6 years, its interest-rate risk is higher than the muni intermediate median but lower
than the high-yield muni median.
As with any Vanguard fund, the management team led by Mathew M. Kiselak, rides its low-cost advantage and largely avoids riskier
pockets of the municipal market, including tobacco bonds and debt from the troubled Puerto Rico territory. Instead it prefers such
stable cash flow sectors as transportation and health-care bonds. Recently, it has found opportunities in toll road bonds, slightly
increasing exposure there while lightening up on health care where uncertainty regarding state Medicare payments has caused
concerns.
The fund has performed as expected over the long term considering its risk profile. Its 5.6% annualized return since Kiselak began
managing the fund in 2010 through August 2014 beats the muni intermediate category average but lags the high-yield muni average,
which is higher risk.
Vanguard Interm-Term Tx-Ex Inv VWITX
An important factor to bear in mind about these funds is their low fees. Since Vanguard's muni team keeps the fund on an even keel,
its low expenses are a powerful advantage. For instance, the fund's 10-year annualized return before expenses of 4.6% for its
Admiral Share class ranks in the peer group's bottom half, but its net-of-expenses return ranks in the top 15%.
The fund has also provided a smoother ride than most of its peers during the past decade by offering better downside protection.
For example, in 2008, the fund was barely in the red and ranked in the top third of the category while most of its peers had bigger
losses. Manager James D'Arcy took charge of this fund, Vanguard's largest muni fund, in June 2013 after managing the firm's
California muni offerings for a couple of years.
The fund's slim 0.20% expense ratio is its key selling point. This makes it the third cheapest of the intermediate-muni category and
puts it among the cheapest of any muni fund across category or vehicle (along with the rest of Vanguard's lineup). Moreover, those
investing $50,000 or more in the fund's Admiral Share class see the price drop down to 0.12%.
Growth
Growth of $20,000 invested in VWAHX ($10,000) and VWITX ($10,000)