EE Bond Phantom Return Analysis

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moda0306
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EE Bond Phantom Return Analysis

Post by moda0306 » Wed Nov 16, 2011 2:15 pm

For people holding EE bonds, as you hold them for year after year as cash, the 3.53% phantom return after 20 years is going to start becoming 1) higher effective return, and 2) fewer years to maturity.  Since shorter-duration securities often have lower rates than long-term bonds, this rate to become much more apparent and lucrative over treasury rates if you're holding a decent chunk of wealth of these things and are trying to decide what to redeem when time comes that you need to access your wealth.  Of course, if you are able to access an EE bond with 1.1% compound returns over the past x? number of years, then that needs to be the jumping-off point for caluclating the ROI of the phantom return going forward

I calculated what the implied return becomes in years after Yr 1, to help with decision-making at those times.  I apologize in advance if it appears a little sloppy.

Phantom = Phantom return calc (unaccessable until yr. 20)
Annual = 1.1% annual return calc
RtM = Rate to Maturity for the 20 year doubling (20th yr being "maturity")
YtM = Years to Maturity for the 20 year doubling (20th yr being "maturity")

Yr Phantom  Annual   RtM       YtM
10,000 10,000 3.53% 20
1 10,350 10,110 3.66% 19
2 10,712 10,221 3.80% 18
3 11,087 10,334 3.96% 17
4 11,475 10,447 4.14% 16
5 11,877 10,562 4.35% 15
6 12,293 10,678 4.58% 14
7 12,723 10,796 4.86% 13
8 13,168 10,915 5.18% 12
9 13,629 11,035 5.56% 11
10 14,106 11,156 6.01% 10
11 14,600 11,279 6.57% 9
12 15,111 11,403 7.28% 8
13 15,640 11,528 8.19% 7
14 16,187 11,655 9.42% 6
15 16,753 11,783 11.16% 5
16 17,340 11,913 13.83% 4
17 17,947 12,044 18.42% 3
18 18,575 12,176 28.16% 2
19 19,225 12,310 62.46% 1
20 20,000 20,000 N/A N/A

As you can see, if you hold an EE bond for 5 years (PS, 5 year treasuries are at .9% about, not deferred), you are now holding an instrument that will offer a 4.35% compound annual return for the next 15 years if held to maturity, based on its redeemable value at that time (no tax figured).  Hold it for 10 years, and you're holding something that will offer you 10 more years at 6.01% if held.

The rates don't change much for the current .6% securities.

I think it's at these points, if rates call for it, that we maybe should move EE bonds into "alternative securities" within our VP portion, because I don't think at these points we can access these as cash without causing ourselves mental strain. That said, we can, at the very least, consider it a nice emergency package within our VP if things get really bad and we say to heck with the phantom return.

Keep in mind, we like our bonds to be volatile in value as marketable securities within the PP for rebalancing purposes (and for purposes of sanity in not seeing our portfolios drop 15% in value).  That said, we rarely rebalance from bonds into other PP assets... which indicates that we really are reaping much of the value of the bonds through the interest they pay out.  We're rewarded with more interest as we go further out on the curve, and similar 20 year treasuries are offering 2.8% return over the next 20 years, without tax-deferral as a built-in benefit.  I think EE's moved out of cash shouldn't be considered bonds within the PP, but definitely an attractive VP bond move.
Last edited by moda0306 on Wed Nov 16, 2011 2:17 pm, edited 1 time in total.
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Re: EE Bond Phantom Return Analysis

Post by Lone Wolf » Wed Nov 16, 2011 2:38 pm

Nice chart!  I think that if rates rise, a chart like this gives you a good guideline as to just how high interest rates must go before you would consider dumping your EE bonds.

Kinda hard to imagine interest rates hitting 65% in year 19, but could be very handy in the early phases.  :)  For example, if interest rates get up to the 5-6% range a few years out, we'll have some interesting decisions to make.  (Unfortunately, these decisions involve trying to predict the future... but hey, EE bonds are allowing us "free roll" on this in ways that other "cash" assets do not.)
moda0306 wrote: I think it's at these points, if rates call for it, that we maybe should move EE bonds into "alternative securities" within our VP portion, because I don't think at these points we can access these as cash without causing ourselves mental strain. That said, we can, at the very least, consider it a nice emergency package within our VP if things get really bad and we say to heck with the phantom return.
I think that I'd want to continue to make them work within the PP.  I think that Browne's rule that you never withdraw money from the PP to fuel your VP is a good one.  I don't see any need to break it here.

IMO, so long as EE bonds are only a modest portion of your cash holdings, there's very little danger that you're going to need to cash them in when it is not to your (perceived) advantage to do so.  MT's concept of "deep cash" is where I think they fit best.  You really try to use things like this last but if push comes to shove, you can do it.

It's sort of like how if you need to sell gold, you start by selling those shares of GLD or IAU you've got in your IRA.  Your flawless American Gold Eagle, though, is intended to be sold "only in case of emergency"!
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Re: EE Bond Phantom Return Analysis

Post by Gumby » Wed Nov 16, 2011 2:57 pm

Nice stuff. But, for me, I still like to consider my Savings Bonds as pure cash and just try not to touch them if I can help it. My Savings Bonds are probably the safest cash I have. After all, they have my name stamped on them!
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Re: EE Bond Phantom Return Analysis

Post by moda0306 » Wed Nov 16, 2011 3:05 pm

Keeping them as cash is totally fine.  I was almost thinking of it as a move to prevent yourself from himming and hawwing come time you really need to get into deep cash.  Further, growing your VP can be dangerous if not for the right reasons (more money you have that you can afford to lose) so if anything a trade off of VP assets would be a welcome addition to any conversion of ee bonds to the VP.

I like how the "deep" portions of our assets (i/ee bonds for cash, physical for gold... along with selling assets within retirement accounts first) naturally fits with the severity of the situation.

For instance, if gold were to really take off, and you have some physical, some ETF taxable, and some ETF in retirement, you'd sell, first, the gold in your retirement account (leaving your taxable (i.e., liquid) funds as a portion of your total funds growing, which will likely be good in a situation where gold explodes).  This works on both the levels of tax-efficiency and liquidity management.

Then, as gold grows even more in relation to the PP, you start selling your ETF in a taxable account.  All along, naturally, your physical gold is growing in proportion to the total gold allocation of the PP, which leaves you buying and selling easily with ETFs, and in a better situation come currency emergency and the like.

Likewise, i/ee bonds are as good as cash, but need only be redeemed if interest rates and/or liquidity needs call for it.

It's a nicely tuned sub-structure to the formal PP that tends to soften the edges involved with selling physical gold and ignoring hand-me-outs that the treasury gives to the middle-class without exposing yourself too much to various risks.
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Re: EE Bond Phantom Return Analysis

Post by Lone Wolf » Wed Nov 16, 2011 3:09 pm

How high would interest rates have to rise before you guys might consider shedding your EE bonds that have an interest rate of, say, 1.1%?  (But, of course, have the implicit "doubling" shadow interest rate.)

As this chart points out, that decision could get tricky down the line, especially when you think about tax deferral.  The longer interest stay ultra-low, though, the sooner that shadow interest rate becomes hard to ignore.
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Re: EE Bond Phantom Return Analysis

Post by moda0306 » Wed Nov 16, 2011 3:19 pm

LW,

It's so hard to figure because these aren't marketable securities with the implied doubling, so in spite of their implied value, you still have to hold them to "maturity" to realize it.

It'd be interesting to calculate the "FMV" of an EE bond at different points in time.

The rate differential over similar treasury instruments, compounding of said interest (normal treasuries pay interest out... savings bonds are like Zeros and compound), tax-deferral, phantom return of EE bonds, principal stability in the face of rising rates, annual contribution limits, and future availability of savings bonds at all make the value of what you are holding on to extremely difficult to calculate.

I would say that even if ST rates rose to over 1.1%, you'd still have to wonder whether it's worth the plunge, given all the other benefits you are holding onto your rights to by keeping your EE bonds.
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Re: EE Bond Phantom Return Analysis

Post by TripleB » Mon Nov 28, 2011 6:53 pm

Thanks for taking the time to calculate this. I had a similar thought about them recently, but didn't go through with it.

From the table, it shows what the break even point would have to be of t-bills at the time, in order to make it worth while to redeem the EE bond prior to 20 years. For example, at the 10 year mark into holding the EE bond, interest rates on Treasury bills would have to exceed 6% in order to make it worthwhile to sell the EE bond early, because the effective yield you get on the EE bond for the last 10 years, is 6% by holding it to the double-point at 20 years.

I don't think this is too complex to figure out, and one could hold these in their cash allocation and then simply compare the chart to current interest rates.

That said, I'd suggest waiting until t-bills surpasses the break even point by at least 1% to 2% because there's a possibility rates will lower again, and you could effectively have the higher rate for the rest of the 20 year period if you held the EE bonds.

However, at the end of the day, I won't bother with these, because the double rate *only* applies to paper EE bonds, and they won't be available past this year. And you can only buy $5k. There's a chance that digital EE bonds will also receive the 20 year doubling treatment, but there's no evidence that suggests that is the case, and there was a post here recently with some evidence that it will NOT count towards digital EE bonds.
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Re: EE Bond Phantom Return Analysis

Post by ZedThou » Tue Nov 29, 2011 11:05 am

TripleB wrote: However, at the end of the day, I won't bother with these, because the double rate *only* applies to paper EE bonds, and they won't be available past this year. And you can only buy $5k. There's a chance that digital EE bonds will also receive the 20 year doubling treatment, but there's no evidence that suggests that is the case, and there was a post here recently with some evidence that it will NOT count towards digital EE bonds.
The doubling at 20 years applies to both electronic and paper EE Bonds. The only difference is in the face value. See http://www.treasurydirect.gov/indiv/res ... dterms.htm
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Re: EE Bond Phantom Return Analysis

Post by MachineGhost » Sun Apr 24, 2016 12:00 am

Pretty neat!  I have four EE-Bonds that hit their "original maturity" of 17 years just 2-3 years ago, thus guaranteeing a 4.16% CAGR, though the current yield to date is about .25% below that.  They're good for another 9-10 years it looks like.
Last edited by MachineGhost on Sun Apr 24, 2016 12:02 am, edited 1 time in total.
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Re: EE Bond Phantom Return Analysis

Post by barrett » Fri Apr 29, 2016 12:51 pm

MG, Thanks for digging up this thread. I remember a rather lengthy discussion between moda and melveyr about the EE Bonds but hadn't seen this phantom return analysis.

Is anyone on here buying EE Bonds now with the guaranteed 20-year doubling? My guess is that most people that own them have no idea about the doubling and likely miss out on it.
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Re: EE Bond Phantom Return Analysis

Post by Austen Heller » Fri Apr 29, 2016 6:26 pm

barrett wrote: Is anyone on here buying EE Bonds now with the guaranteed 20-year doubling?
I actually did the opposite this year.  Having built up a few years worth, I sold all my EE holdings.  The doubling is a great feature, but I just could not stand the 20-year lock-up.  What if I had some expense come up at year 10 or 15, such as a major medical expense, needing the cash to buy a house, or I want to simplify my portfolio because of dementia?  Then I would only get back my principle with essentially no interest.  3.5% per year is not SO tantalizing that I would be willing to lock-up those funds for 20 years.  Better to put the cash into short-term treasuries or CDs.
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Re: EE Bond Phantom Return Analysis

Post by ZedThou » Fri Apr 29, 2016 10:44 pm

Four years ago I maxed out on EE savings bonds for myself and my wife, only $20k. I wasn't excited about tying up that money for 20 years for a measly 3.5% return, but it was intended to be the deepest emergency savings. Redemption of those bonds would be the final resort if disaster happened to strike. So, it was really just an experiment of sorts.

Since then the CPI-U is only up about 4% or so. Seems to be working out okay.
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Re: EE Bond Phantom Return Analysis

Post by barrett » Sat Apr 30, 2016 7:22 am

In years, say, 10 to 15, the EEs start to become tough to cash in because there's already a good deal of sunk psychological cost. During the last four or five years of holding them, one would feel like, "man, I can't redeem these NOW." 20 years is just a long time to wait unless one can just plunk down the money and never think about it again. And that doesn't work in this situation because the strategy requires the investor to reevaluate periodically whether or not it makes sense to continue holding the bonds. 20 years is a quarter of a lifetime (for most people). The math might make sense but the emotional part probably doesn't... although ZedThou seems to be holding up OK.
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