(PUB) Investing 2015

bond funds, like Intermediate-Term Investment-Grade , anyway.

Competitive Yields on Tax-Exempt Funds Yield ———Taxable-Equivalent Yields———

Yield

25% 28% 36.8%* 38.8%* 43.4%* Tax-Ex. MM 0.01% 0.01% 0.01% 0.02% 0.02% 0.02% Adm. Treasury MM 0.01%

Where Munis Belong Okay, let’s talk about where your muni investments most likely should be held— in a taxable account. This gives us an opportunity to distinguish between mini- mizing your tax bill and maximizing your after-tax dollars. Allow me to cherry-pick an example using today’s numbers. Say you have $100,000 to invest in a short-term bond fund. You could buy Limited-Term Tax-Exempt and earn $980 in tax-exempt income (using the fund’s SEC yield of 0.98% as a measure of the income you’ll receive). You’ll owe no federal taxes on the income and keep all $980. Or you could buy Short-Term Investment-Grade with a 1.88% yield, and earn $1,880 of taxable income. If you are in the highest tax bracket of 39.6% (which goes to 43.4% counting the 3.8% health care surtax), you’ll owe $816 in taxes, leaving you with $1,064. By choosing Short-Term Tax-Exempt, you minimized your tax bill, but if the goal is maximizing your

Federal MM 0.06% Prime MM 0.07%

Short-Term Tax-Ex. Ltd.-Term Tax-Ex. 0.48% 0.64% 0.67% 0.76% 0.78% 0.85% Ultra-Short-T Bond 0.66% 0.98% 1.31% 1.36% 1.55% 1.60% 1.73% Short-Term Treasury 0.62% Short-Term Federal 0.78% Short-Term Bond Idx. 1.14% Short-Term Inv.-Gr. 1.88% Interm.-Term Tax-Ex. 1.79% 2.39% 2.49% 2.83% 2.92% 3.16% Int.-Term Treasury 1.41%

Total Bond Market 2.13% Int.-Term Bond Index 2.54% Int.-Term Inv.-Grade 2.79%

Long-Term Tax-Ex. 2.45% 3.27% 3.40% 3.88% 4.00% 4.33% Long-Term Treasury 2.61% Tax-Ex. Bond Index 1.82% 2.43% 2.53% 2.88% 2.97% 3.22% Long-Term Bond Idx. 4.02% High-Yield Tax-Ex. 2.90% 3.87% 4.03% 4.59% 4.74% 5.12% Long-Term Invest.-Gr. 4.07% *Tax equivalent yields incorporate the 3.8% health care surtax into the 33%, 35% and 39.6% tax rates. Data through 9/30/15.

from bonds issued by municipalities in your state is still tax-exempt at the state level. But, like I said, the numbers are pretty small. For instance, 15% or so of Limited-Term Tax-Exempt’s assets are in New York bonds—which is the larg- est weight any state receives in the fund. If you live in New York, income from those bonds is exempt from state taxes. So factoring in state and local taxes >

after-tax dollars, buying Short-Term Investment-Grade, although it increased your taxes due, would have been the better move. Note that I did not include the impact of state or local taxes in that exercise, in part to keep things simple, but also because they do not move the needle too much. Yes, with a national muni bond fund, the portion of the income paid out

You spent a long time covering the energy industry. What do you think of energy now? Oil is half the price it was a year ago. Are we at an inflection point? Right now my view on energy is, at the very best, mixed. There doesn’t seem to be a lot of evidence to suggest that we are about to inflect. It used to be that when oil was down meaningfully, you would buy, and when it was up meaningfully, you’d sell, but it seems to me we have a double- headed problem here. You have got weakening demand, largely via China. You have a supply curve that has shifted meaningfully, given shale and some other non-conventional sources of supply. You’ve got OPEC, which is still stubbornly producing at a high level. So there’s no real evidence that price is going to turn anytime soon. Now just feels too early for me. Let’s turn to financials for a minute. Financials are close to 15% of the portfolio, the highest level since you started on the fund, and more than double the weight of your benchmark. Our exposure to financials is a little bit different than many other dividend investors—it is largely insurance [companies]. There’s not a lot of bank exposure. The big banks have these big balance sheets, where capital is more precious every day, and that has implications for dividend growth. What we do when looking at financials is we try to avoid big bal- ance sheets or balance sheets that have long-term liabilities. So we own property and casualty insurance, insurance broking and asset management. Things like that. We only own a couple of banks in the portfolio right now. You can make pretty strong arguments as to why we own both of them.

we can. If you look at the composition of the portfolio, particularly in the top 10, the names have, on average, slightly more downside protection to them. There’s a little more yield in the portfolio than normal, which has a buffering effect. To be clear, I am not actively managing the portfolio out of fear or cau- tion. But to the extent I feel a little cautious, I can do those things on the margin. But there’s nothing different about the philosophy. There’s noth- ing different about the approach. Speaking of being opportunistic, what were you and your trad- ers doing for Dividend Growth shareholders during the tumult in late August? When you have rapid volatility like that, you don’t really have enough time to do a lot. You might have an opportunity for about a day. The win- dow opens very narrowly and shuts very rapidly. So it’s really hard to take advantage of. Having said all that, what do we do? We are pretty organized in terms of trying to take advantage of those environments. I have a list of five or six names that we are very interested in buying, that have all the characteristics that we like, and we make the trading desk aware of that. If [the trading desk] sees opportunities either in terms of liquidity pre- senting itself or sharp share price changes, [they are] aware that we are interested in doing something. And we have a dialogue that we maintain to make sure that we take advantage of that opportunity. I’ll also do that with existing positons in the portfolio.

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The Independent Adviser for Vanguard Investors • October 2015 • 5

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