INVESTMENT

The real value of your Mooney portfolio


The following analysis is based on “Tax-Smart Portfolio Evaluation and Performance Measurement”, in an upcoming article by Andrew Calot Portfolio Management Journal, And blackout “Tax-efficient trading of municipal bonds, “From Financial Analyst Journal.


Say you have a portfolio of tax-free municipal bonds. How do you determine its value?


Equal amount Coupon Maturity time Date of purchase Purchase price Current basis Current price
100,000 5% Eight years Two years ago 113.3 111.0 106.0
100,000 2% Eight years Two years ago 100.0 100.0 95.0

If you liquidate the portfolio, the revenue will be $ 201,000. But these bonds are in a taxable account – munis should not be kept in the IRA – and have sales tax consequences.

The current tax base of 5% bonds purchased for 113.3 is 111. At the applicable 20% tax rate, selling will reduce your tax by $ 1,000. Therefore, To you The actual value of 5% Muni is $ 107,000.

Let us apply the same analysis to 2% bonds. Selling at Rs 95 would result in a loss of $ 5,000 and tax savings of $ 1,000. Therefore, on a post-tax basis, 2% Muni is valuable At least You 96,000.

But discount munis are more complicated, because the so-called de minimus tax effect must be taken into account. D minimus refers to the tax treatment of the discount. Profits from a large “non-de-minimized” discount are taxed at about 40% of normal income at maturity.

For a 2% bond, a buyer at 95 will have a 2 point tax liability on a 5 point gain. Based on current prices, the price of 2 points eight years ago is 1.7 points today. And this future tax cost is revealed at today’s 95 price – without it, the value of 2% s would be 1.7 points higher, or 96.7!

The 95% to 2% Munir buyer is being given fair compensation for future tax expenses. But how valuable are these bonds to you, considering that you bought them equally?

Since your tax base is 100, you do not pay tax when the 2% bond matures, and therefore the current value of your cash flow is 96.7. It surpassed the post-tax selling price of 96 by 0.7 points! In dollar terms, Keep the value Your 2% Muni is $ 96,700. Since the hold value exceeds the after-tax income from the sale, it would be a mistake to sell only to save tax.

Financial Analyst Journal Current Issue Tile

In short, the actual value of your portfolio is $ 107,000 + $ 96,700 = 203,700, which exceeds the market value of $ 201,000 by $ 2,700. Acceptability is that on a post-tax basis, the value of a portfolio may differ greatly from its reported value. Selling at a loss can be beneficial, but beware of discount munis: you can save on taxes but not enough to compensate you for the high cost of holding. The goal is to maximize post-tax value rather than savings on taxes.

Looking at your Mooney portfolio through a tax-smart lens will open your eyes to the post-tax value.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Image Credit: © Getty Images / PetonVangerp


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Andrew in black

Andrew Kalotai is a leading authority in the evaluation and management of municipal bonds. His recent focus has been on maximizing the after-tax performance of accounts managed individually by dynamic investment and sales strategies. His organization’s fixed income analysis is used by major asset managers and risk-management platforms. 1 Before the founding of Andrew Kalotai Associates in 1990, Colotte was with the Salman Brothers. Prior to Wall Street, he was at Bell Laboratories and AT&T. Academically, he was the founding director of the undergraduate financial engineering program at the Polytechnic University (now part of New York University). He is the co-author of CFA Level II Reading, Fixed-Income Analysis. Colt holds a BS and MS degree from Queens University and a PhD degree from the University of Toronto, all in mathematics. He was inducted into the Hall of Fame in 1997 by the Society for Standing-Income Analysts.



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