TIPS held to maturity as "bottom" of cash component?

[moda0306]

http://www.treasurydirect.gov/indiv/res ... dterms.htm

The fixed portion "stays the same for the life of the bond"... but the inflation piece can go negative to offset the fixed return.

[AdamA]

You can't lose your principal with a T-bill either, so what are the questions you should ask yourself when trying to choose between the two?

[MediumTex]

Right, but what am I comparing the Ibond to?  ie, "I can get 2% + interest from the Ibond versus X% for the ? bill/bond/note?"

Nothing is really comparable to I-bonds.  There isn't anything else in the bond market that can give you an inflation-adjusted interest rate for up to 30 years with no principal risk.

The tax deferral is just gravy.

For PP purposes, it is to me a perfect option for cash.

Note the $5,000 a year limit, though. 

[MediumTex]

You can't lose your principal with a T-bill either, so what are the questions you should ask yourself when trying to choose between the two?

For a couple of years now, I-bonds have provided a MUCH higher return than t-bills.

Even if the yield spread between t-bills and I-bonds closed, you would still have the better tax treatment of interest using I-bonds.

I expect that I-bonds will be discontinued at some point.  It's too good a deal.

[AdamA]

Very interesting...do they hold up during deflationary periods?  I saw in Nov of 09 (I think) there was negative inflation.

 

[moda0306]

The inflation rate is adjusted to inflation, not the balance of hte bond itself... which, when you think about it, isn't that the same for any short-term bond... if the inflation rate is x, the bond will demand x+?.

Interesting, I've never gotten this interested in cash before.

[MediumTex]

Very interesting...do they hold up during deflationary periods?  I saw in Nov of 09 (I think) there was negative inflation.
 

In periods of deflation, interest rates can go negative.

In the case of I-bonds, your principal will never be reduced, so negative interest rates would just result in no interest payments during the period of deflationary negative interest rates.

Contrast this to t-bills during periods of deflation, where yields can actually be negative under extreme conditions.

[moda0306]

http://www.treasurydirect.gov/indiv/res ... dterms.htm

http://www.treasury.gov/resource-center ... &year=2007

Compare rates in previous years.  In Nov. 2007, even very ST treasuries were yeilding almost 4%, i bonds were at a combined 2.73%.

It varies, but often Ibonds seem to offer less than ideal ST rates.  Tax deferral only provides so much value, and really aren't all ST rates inflation adjusted for the reasons I mentioned before?

[MediumTex]

http://www.treasurydirect.gov/indiv/res ... dterms.htm

http://www.treasury.gov/resource-center ... &year=2007

Compare rates in previous years.  In Nov. 2007, even very ST treasuries were yeilding almost 4%, i bonds were at a combined 2.73%.

It varies, but often Ibonds seem to offer less than ideal ST rates.  Tax deferral only provides so much value, and really aren't all ST rates inflation adjusted for the reasons I mentioned before?

Check your math.  I've got May 1, 2007, I-bonds yielding 5.31%.

[AdamA]

So, why the higher yield for Ibonds?  Is it because you have to hold them for at least one year?  Is it b/c you lose 3 month interest payments if you sell them in under five years? 

[moda0306]

Crap, is each of those the payment for that 6-month period and therefore approx. half a year's interest?  That means it's basically doubled what I was calculating?

Amazing.  I-bonds are my new favorite security.

[moda0306]

Adam,

Might just be a hand-me-out to the middle class.  If you can only purchase $5,000 per year in i-bonds, it was maybe designed to give the middle class a decent tax-deferred rate of return without giving a handout to wallstreet.

[MediumTex]

Crap, is each of those the payment for that 6-month period and therefore approx. half a year's interest?  That means it's basically doubled what I was calculating?

Amazing.  I-bonds are my new favorite security.

It's more complicated than that.  It's a screwy formula.

[moda0306]

I found the formula... a bit screwy but I like these things.

Is the inflation adjustment the same no matter when you purchased your original ibond? 

[moda0306]

I tried another date just to check Nov. 2001.  4.4% for I-bonds vs 2.1 for 1 year treasury and 2.5 for 3 year treasury.

By god we've discovered something beautiful.

[moda0306]

I'm literally losing it after looking at these I-bond returns.  They are creaming 1-3 year treasuries.

Better start the buying spree w/ the $5,000 limit each year.

[Lone Wolf]

I have read on them, and I think I understand how they work.  The thing is, I can't really figure out how the fixed rate is determined.  

I also have no idea how the fixed rate is determined.  For all I know, it may be arbitrary.  Really makes me curious, especially with it sitting at 0% fixed rate right now.

One thing I like about I-bonds is that you get some real inflation protection (as their rates are indexed to CPI-U.)  T-bills of course also "slightly" compensate you for inflation via their interest rate but typically with a rate lower than the I-bond composite rate.  Plus, you pay taxes on the interest from t-bills while I-bond taxes can be deferred for 30 years.  So with t-bills I think you really do get a bit of a bad deal on your cash when inflation comes because you must pay the government tax money on the inflation it has caused.  (I find this very annoying.)

The variable rate is based on the CPI-U (which from what I understand includes food and energy but not health care.)  This tends to put I-bond rates at rates that are competitive with slightly longer-term treasury securities but without the interest rate risk.

They have the following disadvantages:
1. Setting up a TreasuryDirect account involves some rigmarole.
2. They have an irritating $5,000 per year limit from TreasuryDirect, plus an additional $5,000 per year limit as paper bonds.
3. When you walk into the bank and ask to purchase them, the teller may look at you like you have two heads.  Apparently nobody really bothers to buy these things except the occasional granny.  So it's just Lone Wolf and the grannies rockin' the I-bonds.  (Speaking only for my local branch -- it sounds like MT has been buying these for years!)
4. They cannot be traded on the secondary market.  You can either cash them in or hold on to them.
5. You must hold on to them for five years to avoid having to forfeit any interest.

I'm afraid that MT might be right that they'll try to discontinue them.  The ever-shrinking limits kind of hint at that.  Me and the grannies will get together and have a good cry when that happens.

[moda0306]

What a great tool for safe, tax-efficient, inflation protected return for the middle class.... A complete shame it's not being used better.

[MediumTex]

I-bonds rock!!!

[Lone Wolf]

I think they set rates a couple of times each year - say 4.75% total, and if inflation is 2% then they become inflation + 2.75% type returns.  If next week inflation rises to 3% they're in effect inflation + 1.75%.  If it keeps going that way they might set them to maybe 5% at the next 6 month review...etc.  But I'm way from sure.

Yeah, in the US the I-series savings bond "fixed rates" are set twice per year, May and November.  So you're theorizing that fixed rate might be reverse-engineered to meet a particular target?  Whatever the Treasury feels is the right "real" rate of return for the composite to produce?  Certainly as good of an explanation as I've got.  The fixed rate is a bit opaque to me.

Even at 0% fixed rate they're worth having (IMO) since the composite rate can't go below 0% (even if CPI-U goes negative for a stretch.)  The tax deferral makes these lousy real yields better than the lousy real yields of TIPS.  :)

Sorry to hear your equivalent UK savings bond got deep-sixed, Clive.    Hopefully they'll return one day!

[AdamA]

Great info, Lone Wolf.  I guess it's a good idea to keep some cash in something else that's a tiny bit more liquid if you're going to use I-bonds (to rebalance). 

It's more the tax benefit I like than anything else. 

I am a bit skeptical of the government issuing inflation protected anything.  It's kinda the fox guarding the hen house.  They can easily manipulate the CPI (no food or energy??!!), and you might not get true inflation protection, certainly not what you get with gold (which responds not only to inflation, but also the fear of inflation).    Nonetheless, the tax advantage and at least some inflation protection sounds like pretty good deal. 

Adam

[MediumTex]

I am a bit skeptical of the government issuing inflation protected anything.  It's kinda the fox guarding the hen house.  They can easily manipulate the CPI (no food or energy??!!), and you might not get true inflation protection, certainly not what you get with gold (which responds not only to inflation, but also the fear of inflation).    Nonetheless, the tax advantage and at least some inflation protection sounds like pretty good deal. 

Adam

This is an important point and I think that one of the good uses of I-bonds as a cash component of the PP (as opposed to a gold substitute) is that you are NOT relying on the government to accurately track or compensate you for inflation; rather, you are simply recognizing that I-bonds seem to be a way of getting higher returns than t-bills provide with better tax treatment, but with the same safety.

[moda0306]

Plus, after 1 year you can sell them, so if the inflation calculation is pathetically inadequate, then just sell them and buy a t-bill.  I don't necessarily "trust" them either, but luckily these securities are liquid so you don't need to trust them.  Just sell them when they quit being honest.

[fnord123]

Well bleh, my TIPS thread has been hijacked into an I-Bonds discussion.

I-Bonds are great for all the reasons mentioned. They also are limited to $10K/year investment.  So assume somebody has $40K in the cash segment of their PP.  They could go get $10K in I-Bonds (5 online, 5 paper). Great. Now what about the remaining 30K?

They can put the $30K in a FDIC insured account, taking on FDIC risk. All yields will be taxed as income both by the feds and by the states.
They can put the $30K in short term treasuries (or an equivalent ETF or mutual fund). All yields will be federally taxed (but not state or local iirc).

My thought was to put a portion of that $30K (let's say, $10K) into TIPS and hold to maturity.  If I understand correctly, the tax treatment here is identical to the tax treatment that short term treasuries get, so that isn't an argument against TIPS, is it?

Is the anti-TIPS sentiment the idea that someone will need all of their cash segment (not just 75% of it) fully liquid?  The only possible scenario I can come up with for that is if the other 3 segments (gold/LT treasuries/stocks) drop to something like 10% of their value and one needs to rebalance 80%+ of the cash in their cash segment into the other segments.  For that to happen, the S&P 500 would need to hit 130, gold $130/ounce, and 30 year treasury interest rates would need to be something like 0.2%.  Is the economy even functioning at that point?  Or is there some other scenario I am missing?

[MediumTex]

I-bonds are also a good way of teaching your kids about money.

I showed my daughter an I-bond and told her that if I put it in a drawer for 20 years it would be worth a lot more than it is today. 

I then showed her some currency and told her that if I put it in a drawer for 20 years it would be worth a lot less than it is today.

I then showed her a silver eagle coin and told her that if I put it in a drawer for 2000 years it would basically be worth the same as it is today.

She looked at me quizzically.