Home Adviser Fund Update Vanguard Opening New Bond Fund Published December 5, 2014 Vanguard Goes Ultra Short Last week, Vanguard announced that it will be launching a new fixed-income fund in February: The actively managed Ultra-Short-Term BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates.. The fund will have a weighted maturity of 0 to 2 years and be managed by two veterans from its Fixed Income Group, Gregory Nassour and David Van Ommeren. The portfolio will hold at least 65% of assets in high-quality bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates., but is permitted to invest up to 30% in “medium-quality” bonds, according to the preliminary prospectus. The fund managers will also be able to put 5% of the portfolio into non-investment-grade bonds. Vanguard has argued for some time that the risksThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. of investing in short-term or even intermediate-term bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. funds are mitigated by the value in rising monthly distributions—especially when they are reinvested. However, the demand from risk-averse income investors over the last few years for “safer” fixed-income or alternative fund products has been high, and this new fund is Vanguard’s attempt to meet that demand. Ultra-Short-Term Bond’s launch should offer Vanguard investors a low-risk way to deal with the rise of interest rates likely on the horizon sometime next year (funds with lower average maturities and durations typically feel less of an impact from changes in interest rates). Ultra-short bonds can also be an appealing option for investors who are taking income distributions out of their holdings rather than reinvesting. Price moves will likely be small and once interest rates rise, these type of bond funds could see yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. rise at a decent rate. Vanguard already offers an ultra-short municipal bond fund, Short-Term Tax-Exempt. The new fund will serve as its complement on the taxable, investment-grade side of the ledger. Ultra-Short-Term Bond’s Investor shares will carry a 0.20% expense ratio with a minimum initial investment of $3,000, while its Admiral shares will charge 0.12% and require a $50,000 initial investment. IRS Clarifies Key RolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax. Question This fall, in a decision friendly to taxpayers, the IRS released unequivocal guidance that finally cleared up a murky area of retirement investing tax law: 401(k) investors are now expressly permitted to split distributions consisting of both tax-free and taxable earnings between a Roth IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. and a traditional IRA. Prior to the clarification, IRA investors had no official guidance on how to deal with rolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax. distributions from 401(k) plansA 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn. Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn. if that money included after-tax contributions. An IRS notice from 2009 did not expressly forbid splitting pre- and after-tax rolloversThe process of transferring funds from one retirement account to another, typically without incurring a tax. into separate vehicles, but doing so required a number of transactions and caused confusion among tax professionals as to the legality of doing so. It may seem like an obscure ruling, but for people switching jobs mid-career who want to move their retirement savings from their previous employer’s plan into a more customizable IRA, it’s a very common concern. Take Mike, who got a new job cross country and wants to do a rollover, as his previous employer’s plan had only limited investment options. Mike’s 401(k) account contains $100,000, of which $80,000 came from pretax salary deferrals and compounded earnings, and $20,000 was from after-tax contributions. He could certainly roll the entire amount tax-free into an IRA, though future earnings on pre- and after-tax money would be subject to taxes when distributed. This is not ideal, because Mike would need to file IRS Form 8606 to prorate the nontaxable and taxable distribution amounts, or else have to pay income taxes on them. In this simple example, it makes more sense for Mike to send his pretax money to a traditional IRA (paying income taxes when he takes distributions in retirement) and convert his after-tax money into a Roth IRA (getting tax-free distributions later), something he is now explicitly permitted to do. The IRS ruling, Notice 2014-54, also applies to rollovers from 403(b) and 457 plans. One important note: Allocating after-tax money to Roth IRAs is permissible only when an entire retirement account (with both pre- and after-tax dollars) is rolled over at once. Partial rollovers are still subject to the pro rata rule, which requires any withdrawal to have a proportionate balance of taxable and non-taxable dollars. The new rule officially goes into effect on Jan. 1, 2015, though investors were free to use this strategy as of Sept. 18, 2014, when it was approved. Despite this clarification from the IRS, the rules and regulations of tax-deferred investing can be complex and overwhelming. We recommend consulting with a trusted financial adviser to maximize your tax savings when investing for retirement. About Adviser Investments Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., fixed-income investing, tactical strategies and financial planning. 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