I was obsessed with doing the math but it was a struggle since I'm still learning. If I've made some mistakes, please let me know!
Tax Equivalent Yield Formula
tax equivalent yield = yield / ( 1 - applicable tax rates)
Operation Parameters
- Federal Marginal Tax Rate: 25%
- MA State Tax Rate: 5.3%
- Amount invested: $20,000
Federal tax is deferred on an I-Bond, but it is exempt from MA tax. Since we can't predict the future fixed rates or the CPI-U, I assumed a buy in late October and selling in 14 months. This would count as 15 months and the 3 months of as yet unknown interest would be forfeit. Jonathan has already done all the hard work to figure out the blended rate in this case as 5.02%. Since only state tax can be factored in here, the taxable equivalent yield is 5.29%. The yield is paid out as interest (cash).
Option 2: MA Sales Tax Bond (5.52%)
Digging around the Fidelity site, I found a single municipal bond with a relatively high yield to compare. The current price is $108.511 per $100 so $20,000 would buy 184 bonds ( I think I have that right). The coupon pays 5% so the yield is currently calculated at 3.85%. Because this bond is federal and state tax free, the taxable equivalent yield is just over 5.52%
Option 3: FDMMX (approx 5.82%)
The Fidelity Massachusetts Municipal Income Fund is federal and state tax free. This fund requires an initial investment of $10,000. The current price per share is $12.03 so $20k would by roughly 1662 shares. The dividend is currently $0.04 per share. Given that dividends are re-invested (They *are* reinvested, right? if so, approx 5-6 shares a month added), I ended up estimating a yield of 4.06 which is a taxable equivalent yield of 5.82%
So if my calculations are right I-Bonds don't look that sexy compared to the munis (I-Bonds are sexy for other reasons though including low barrier to entry for such a nice rate) and a taxable bond fund would have to yield at least 5.52% after all expenses and loads were accounted for in order to really compete with municipal bonds...
Or am I all wrong?
[Update: Of course, Dinkytown has a helpful calculator for figuring out TEY on a Municipal Bond]
Thanks for the additional information and clarity hedged.
ReplyDeleteMy purpose was specifically to try out some TEY calculations, to get a view on comparitive TEYs.
What isn't clear in the post is that the original question was I-Bonds vs. Calvert Income Fund and I was curious about some of the other comparisons myself so hence the TEY
And you are also right that I did not include Fidelity's 0.42 expense ratio etc but I'd love to know how to do that math to do that
Anyone?
And I'm certainly no financial expert nor do I claim expertise. I'm just a layperson struggling with all this info, so the post was just as much about getting further information as it was about sharing a small piece of my process.
I believe the NAV value of the Fidelity Tax-Free MA Muni Bond fund already is "net" (net asset value) of the expense ratio, so the .04 cent per share yield you indicate already accounts for expenses
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