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The True Worth of Your Muni Portfolio


The next evaluation is predicated on “Tax-Good Portfolio Valuation and Efficiency Measurement,” Andrew Kalotay’s forthcoming article within the Journal of Portfolio Administration, and Kalotay’s “Tax-Environment friendly Buying and selling of Municipal Bonds,” from the Monetary Analysts Journal.


Say you’ve gotten a portfolio composed of two tax-exempt municipal bonds. How do you establish its worth?


Par Quantity Coupon Time to Maturity Buy Date Buy Value Present Foundation Present Value
$100,000 5% Eight years Two Years In the past 113.3 111.0 106.0
$100,000 2% Eight years Two Years In the past 100.0 100.0 95.0

For those who liquidated the portfolio, the proceeds could be $201,000. However these bonds are in a taxable account — munis shouldn’t be held in an IRA — and promoting has tax penalties.

The present tax foundation of the 5% bond bought for 113.3 is 111. Promoting for 106 would end in a long-term $5,000 capital loss. On the relevant 20% tax fee, promoting would scale back your taxes by $1,000. Due to this fact, to you the true value of the 5% munis is $107,000.

Let’s apply the identical evaluation to the two% bond. A sale at 95 would end in a $5,000 loss and a $1,000 tax financial savings. Due to this fact, on an after-tax foundation, the two% munis are value no less than $96,000 to you.

However low cost munis are extra difficult, as a result of the so-called de minimis tax impact should be taken into consideration. De minimis refers back to the tax remedy of the low cost. The acquire on a big “non-de-minimis” low cost is taxed at maturity as bizarre earnings, at roughly 40%.

For the two% bonds, a purchaser at 95 would have a 2 level tax legal responsibility on the 5 level acquire. On a gift worth foundation, 2 factors eight years from now are value 1.7 factors right now. And this future tax price is manifested in right now’s 95 value — with out it, the twopercents could be value 1.7 factors extra, or 96.7!

The client of the two% munis at 95 is being pretty compensated for the long run tax price. However how a lot are these bonds value to you, contemplating that you just purchased them at par? 

As a result of your tax foundation is 100, you don’t pay tax when the two% bonds mature, and subsequently the current worth of your money flows is 96.7. This exceeds the after-tax gross sales value of 96 by 0.7 factors! In greenback phrases, the maintain worth of your 2% munis is $96,700. As a result of the maintain worth exceeds the after-tax proceeds from the sale, it could be a blunder to promote simply to avoid wasting on taxes.

Financial Analysts Journal Current Issue Tile

In abstract, the true value of your portfolio is $107,000 + $96,700 = $203,700, which exceeds the $201,000 market worth by $2,700. The takeaway is that on an after-tax foundation, the worth of a portfolio could also be very completely different from its reported worth. Promoting at a loss could also be useful, however watch out with low cost munis: It’s possible you’ll save on taxes however not sufficient to compensate you for the upper worth of holding. The purpose is to maximise after-tax worth, relatively than to avoid wasting on taxes.

Viewing your muni portfolio by way of a tax-smart lens will open your eyes to its true after-tax worth.

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All posts are the opinion of the writer. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the writer’s employer.

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Andrew Kalotay

Andrew Kalotay is a number one authority on the valuation and administration of municipal bonds. His current focus has been on maximizing the after-tax efficiency of individually managed accounts by dynamic funding and gross sales methods. His agency’s fixed-income analytics are utilized by main asset managers and risk-management platforms. Earlier than establishing Andrew Kalotay Associates in 1990, Kalotay was with Salomon Brothers. Previous to Wall Avenue, he was at Bell Laboratories and AT&T. On the tutorial facet, he was the founding director of the graduate monetary engineering program at Polytechnic College (now a part of New York College). He’s a co-author of the CFA Degree II studying, Fastened-Revenue Evaluation. Kalotay holds a BS and MS diploma from Queen’s College and a PhD from the College of Toronto, all in arithmetic. He was inducted into the Fastened-Revenue Analyst Society’s “Corridor of Fame” in 1997.

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