California Municipal Bonds

Investing in Municipal Bonds

(Please read the Disclaimer first. If you disagree, please stop reading my blog).

In a nutshell: 

The US tax law is complex and confusing. In Bay Area, most of us have high income so our highest tax federal tax bracket is easily > 35%, plus CA state income tax 10% + sales tax, we would easily pay 50% for additional income. This additional income includes stock investments, dividends, interests, ESPP, RSU, options, etc. outside your normal w-2 wages.

Solutions: 

• You max out pre-tax deduction in 401K or 403B plan. I think it's $17,500/yr for one person. A couple can deduct $35k before federal + state tax get you. You may also deduct $5k/yr child credit.
• As Chinese, we always save extra money for investment vhecles like stock, bond, or real estate but we will be taxed for capital gains, interests (债券利息), dividends(股票红利) at our highest tax bracket.
• CA municipal bonds are one excellent tax-free (fed & state) solution. However, you may face many choices for state bonds, city bonds, or utility bonds. Then the easiest way is to buy them in the form of mutual fund ( https://investments.pimco.com/Products/pages/632.aspx) or ETFs like  AKP, BFZ, PZC (6.65%). Remember, they are for your regular accounts. Based on my exp, I work hard to earn > 10% return a year, then I have to pay so much tax. It's so frustrating.

Motives:

• Stock market is always volatile.
• Even if we beat the S&P 500 performance, we have to pay tax. This easily sinks our annual return.
• When the stock goes against us, we try to cut loss quickly (< 30 days) but this triggers wash-sale easily. Therefore I cannot deduct the loss from my other capital gains. Keep holding it would trigger more loss.
• Long bonds are volatile too. The longer the bond is, the more volatile its. TLT (20-yr) > SHY (2-yr) but with higher returns. 
• Low quality bonds are volatile too. The riskier the bond is, the more volatile its. Think of corporate junk bonds, Greek bonds, etc. You may earn a high annual ROI but lose the principal instead (保利不保本).
• Bonds are negatively correlate to inflation, and hence the S&P movement. We can use TIP to stay ahead of inflation.
• Most of bond interests are taxable but CA muni bonds are exempted. 

How to purchase

• Call your broker for specific state, city, local bonds,
• Buy mutual funds intended for CA muni bonds.
• Buy ETFs intended for CA muni bonds in your brokerage accounts.