EE Series Savings Bonds

Discussion of the Cash portion of the Permanent Portfolio

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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 1:42 pm

The only way EE's would probably win out is such a deflationary force that CPI actually decreases, or doesn't increase.

Given our natural-resource situation (and growing world economies) I don't see this as the case.

But the term "deflationary spiral" didn't come about for no reason.  The way I see it is this:

I-bonds: insurance against stubbornly low st rates in the face of commodity inflation (what we have now)
EE-bonds: insurance against flat-out deflation (what appeared might be the case in 2008)

Funny thing is, the combination of the two that I mentioned in the other thread would provide an interesting bond instrument: .55% fixed return + 1.75% phantom 20 year return + 1/2 CPI adjustment.  Not. Too. Shabby.
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Re: EE Series Savings Bonds

Post by Lone Wolf » Tue May 17, 2011 2:06 pm

moda0306 wrote: EE-bonds: insurance against flat-out deflation (what appeared might be the case in 2008)
There's also the "insurance against annual I-bond purchase limit" angle.  This is especially relevant if someone has been accumulating cash for a while but has only more recently discovered savings bonds.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 2:16 pm

The idea of a couple being able to pile $40,000 a year into these things (I & EE total) is pretty crazy.  That's $400,000 from age 40-50... often peak earning years.

Too bad you can't do it more easily through a Vanguard account or at least 100% through treasury-direct... though you wouldn't be able to high-five the Grandmas at the bank in the i/ee isle.

And most tax-deferral options having income limits, these things should be extremely attractive to relatively wealthy individuals, as they often are 1) concerned more with preserving wealth than growing it, 2) are in extremely high ordinary brackets (35%), and 3) would be able to max out every year and could afford to use their other investments as income while their savings bonds grow.

Can a financial advisor purchase savings bonds, either paper or through treasury direct, on behalf of their clients?
Last edited by moda0306 on Tue May 17, 2011 2:19 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 2:43 pm

I'm on a roll... why stop.

I think, if we step back and look at the implications of these, it's really something.  To simplify things a bit, most of us don't like the fact that our investments may pay less than our mortgage costs... let's assume 4% after the tax-benefit. LT bonds will beat that, so we're left with cash, for many reasons (for some people) being the tough pill to swallow with much more than their emergency-fund wealth.

Right now rates are being held unusually low on the short end of the duration curve, though they will probably rebound.  Imagining two scenarios here for the next 10 years:

1) short rates go up to 4%+
2) short rates stay around .5-1.5%

Obviously there's a hole there, but for illustrative purposes here you go.  

If rates rise to 4%+, you drop your ee bonds, and either buy new ones, or invest in cash in your tax-deferred accounts, and beat your mortgage rate.

If rates stay low, say for a decade, your EE bond will remain attractive as cash, and have earned the "phantom" 3.5% along the way (obviously), but lets say at that point rates rise... well you've now got a higher "phantom" rate since the maturity is so much closer. That is now like a 8.1% 10 year cd (right?... 7%+1.1%), and you really can't beat it at that point (probably, depending on how high rates actually go).

So at 20 years, the double face value starts to look pretty good after only 10 years of earning your fixed 1.1%.  At that point, it may be best to not look at your EE bond as cash at all, and move it to your VP, since redeeming the thing would be a real buzz-kill and be throwing out a lot of built-up benefit.  So here are your results:

1) Short-rates rose within a few years to 4%+ and you are quickly, again, beating your mortgage, with only a short period of lag.
2) At the end of 20 years, you will have realized a 4.6% return, tax-deferred, and beat your mortgage.

I know this is all intuitive on some levels, but I know it's tough for some people to borrow at 5% and invest at 1% (me, especially), so I thought I'd just connect the dots a bit so people can see how the future may play out and that cash doesn't necessarily have to be the loser some may think it will be.
Last edited by moda0306 on Tue May 17, 2011 2:47 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 3:47 pm

LW,

I'm starting to question my theory that the I-bond is the "better bond"... or at least not as much as I'd once thought.  I'd say the i-bond, currently, is the "better short-term bet," at 4.6%... but the idea that we'll have greater than 1.1% CPI increase (1.1% being the interest rate on ee bonds (sans 20 yr doubling)) without having some fixed interest rate increase is unlikely.  Or more simply put, the CPI adjustment alone is nice for the short-term, but won't be the long-term panacea that EE bonds may be.  The best I-bonds will do (TODAY's I-bonds) is keep up with CPI... and while this is not a bad thing, short-term rates often mock inflation pretty closely, and it doesn't hold the potential "BOOM" factor that EE bonds do.

EE-bonds, while less appealing in the short-term (which, I'll admit, is the point of cash... it's not supposed to function as a LT bond), if deflation takes hold, would be the preferred holding at 4.6% if held for 20 years.  While a less-likely scenario, I think the ability for EE bonds to be EXTREMELY beneficial even in a falling CPI/interest environment would maybe make someone diversify into EE's before completely maxing out their yearly dose of I bonds.  A 4.6% return for 20 years when s-t rates are <1% and long-term rates are dropping has some amazing implications.

Both I and EE bonds let you "cheat" or "arbitrage" in certain ways... but the environments in which they will succeed most will differ, and I think holding some of EE is a really solid move, especially as a deflationist.  Don't get me wrong... the EE bond is a long play and is almost not even using cash as cash at some point... so maybe this debate is a bit moot.
Last edited by moda0306 on Tue May 17, 2011 3:51 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by Lone Wolf » Tue May 17, 2011 4:26 pm

moda0306 wrote: I'm starting to question my theory that the I-bond is the "better bond"... or at least not as much as I'd once thought.  I'd say the i-bond, currently, is the "better short-term bet," at 4.6%... but the idea that we'll have greater than 1.1% CPI increase (1.1% being the interest rate on ee bonds (sans 20 yr doubling)) without having some fixed interest rate increase is unlikely.  Or more simply put, the CPI adjustment alone is nice for the short-term, but won't be the long-term panacea that EE bonds may be.  The best I-bonds will do (TODAY's I-bonds) is keep up with CPI... and while this is not a bad thing, short-term rates often mock inflation pretty closely, and it doesn't hold the potential "BOOM" factor that EE bonds do.
I might not be following, but let me just make sure everything is clear.  The "fixed rate" of the EE bond is set on the day that you purchase it.  Thus, if interest rates rise in the future, only future purchases of EE bonds will benefit.  This means that when rates rise, you'd want to start consider selling your EE's.  (A decision that would involve multiple factors.)

I think you understand that bit, just calling it out again.  What you're excited about is the "what if rates fall or stay flat forever" scenario.  In this case, you keep those EE bonds and 20 years later they've doubled while everything else was languishing.

At heart I am an inflationist but I'm trying, trying not to pick sides.  Thus, I completely agree and hold the EEs as both a) an instrument that beats 3-year Treasury rates and b) will kick butt in a long-term deflationary scenario w/ low interest rates.  Deciding when to offload an EE will be hard because it involves some degree of guessing the future.
moda0306 wrote: EE-bonds, while less appealing in the short-term (which, I'll admit, is the point of cash... it's not supposed to function as a LT bond), if deflation takes hold, would be the preferred holding at 4.6% if held for 20 years.  While a less-likely scenario, I think the ability for EE bonds to be EXTREMELY beneficial even in a falling CPI/interest environment would maybe make someone diversify into EE's before completely maxing out their yearly dose of I bonds.  A 4.6% return for 20 years when s-t rates are <1% and long-term rates are dropping has some amazing implications.
Definitely less appealing than I-bonds for the short term but more appealing than short-term T-bills.  Once you've held them for 1 year they are liquid enough (with the 3-month interest penalty.)

I'm confused where the "4.6% for 20 years" you mentioned comes from, though.  I calculate a 20-year doubling as being equivalent to 3.53% or so per year.  Let me know if I am off, though.

Are you perhaps thinking that you get the fixed rate as well as the doubling?  Unfortunately, all that happens is at 20 years, if your bond has not reached face value (double your purchase price), your bond is worth face value.  Thus, at 20 years your bond will be worth either the principal + accrued interest or face value, whichever is greater.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 4:33 pm

LW,

To your first point, yes I understand that as rates rise you'd want to offload your EE bonds... and yes, the deflationary scenario would be the ideal.

To your second point, dangit!  I didn't realize the bond mearly doubled in value, but lost all the other accrued interest.

That softens its appeal, but still I think you get the point.  In a sustained deflation, EE bonds will still provide a heckuva arbitrage.

Good catch.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 4:41 pm

LW,

You killed my dreams of getting 1.1% AND the doubling to achieve a 4.6% rate... that killed me.

Nonetheless, a 20-year treasury bond (though you can redeem them for a gain or loss at any time), is at about 3.9% interest right now, which, when taxes are taken into consideration, especially in higher brackets, in the long-term will not beat the 3.5% tax-deferred of an EE bond.

Seems to be a pretty solid option for the VP at least, if you like the idea of having a lucrative cash-like investlment that doubles as a deflationary insurance policy.

It will be interesting to see how long the treasury offers these at current terms if we have lowering of interest rates.  The idea of buying these in 2008 when 30 year treasuries were offering 2.6% and deflation appeared imminent would have appealed to me, though in clear violation of PP tinkering rules.
Last edited by moda0306 on Tue May 17, 2011 4:50 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by fnord123 » Tue May 17, 2011 5:01 pm

moda0306 wrote:To your second point, dangit!  I didn't realize the bond mearly doubled in value, but lost all the other accrued interest.

That softens its appeal, but still I think you get the point.  In a sustained deflation, EE bonds will still provide a heckuva arbitrage.
I was wondering about your stacking of the doubling with the incremental interest rate, as that didn't match my understanding of EE bonds either.

Actually, upon thinking on EE bonds more, I think they may have a drawback, specifically around the fact that they do not compound.  Savings accounts are taxed every year, but they compound in value.  EE bonds do not compound as far as I understand it (one gets a fixed interest payment every year), but are taxed at the end.  Below is a table that compares the two. The first dollar amount in each row is the savings account balance, based on the given interest rate. It includes a 20% tax payment on interest earned that year.  The second dollar amount is the value the EE-bond could be cashed out that year, with a 20% tax payment on the interest of the EE bond. 

Code: Select all

Tax Rate:	20.00%	
Interest Rate:	1.10%	
	Savings Acct Balance	EE-Bond Cash-Out Value
Year	$10,000	$10,000
1	$10,088	$10,088
2	$10,177	$10,176
3	$10,266	$10,264
4	$10,357	$10,352
5	$10,448	$10,440
6	$10,540	$10,528
7	$10,633	$10,616
8	$10,726	$10,704
9	$10,820	$10,792
10	$10,916	$10,880
11	$11,012	$10,968
12	$11,109	$11,056
13	$11,206	$11,144
14	$11,305	$11,232
15	$11,404	$11,320
16	$11,505	$11,408
17	$11,606	$11,496
18	$11,708	$11,584
19	$11,811	$11,672
20	$11,915	$18,000
As it turns out, if we assume an identical interest rate for the EE-bond and the savings account, the benefit of compounding makes the savings account a better choice unless one holds the EE-bond until maturity.    This holds true for any combination of interest rates and tax rates.

This doesn't mean EE-bonds are bad per se, it just means that if one can get an interest rate in a savings account that is comparable, and is comfortable with the additional risk, that the savings account may be the better choice.

P.S. Note that this ignores default risk for the FDIC/NCUA. However, if one holds a treasury ladder and gets an equal interest rate (1.1%) the same compounding benefit applies.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 5:07 pm

fnord,

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

Interest is compounded within EE bonds, it would appear.  The 1.1% appears, given the terms, to be compounded, and the 3.53%, I'm quite sure, is a compounded calculation of what it would take to double your money in 20 years.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 5:12 pm

So LW,

Basically, the 20 year doubling becomes less and less relavent as the fixed rate becomes closer and closer to 3.5%, correct.... since there will really be little-to-no 20-year step-up?

I guess the implication of this are that the treasury's keeping the 20-year rule is more and more worth considering as long-term rates drop.

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

Further, comparing fixed i-bond rates and fixed ee bond rates is also somewhat interesting (see above links).  EE's historically offer much more lucrative fixed rates, but the thing is, when those rates are fixed at or near 3.5%, the doubling is almost a moot point.  Only as rates lower does that feature tend to stand out.  

So basically, folks, keep an eye on long-term rates as well as short-term.  If they get low enough, the 3.5% 20-year return could be a nice return to grab with some money that you don't want to take too much principal risk with in a VP... maybe an offset to some miners or something if you're an inflationist.
Last edited by moda0306 on Tue May 17, 2011 5:13 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by MediumTex » Tue May 17, 2011 5:19 pm

I view each of the PP asset classes as potentially having some "deep storage" items.

What I mean by deep storage is assets that you are unlikely EVER to sell, since no rebalancing event is going to completely clean out any of the PP assets.

For the cash piece, I view savings bonds as deep storage items.  I would try to configure a PP with savings bonds so that you will never have to sell any of your bonds to rebalance.  This probably results in a savings bond target of 20-30% of your cash PP holdings.

Just a thought.
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Re: EE Series Savings Bonds

Post by moda0306 » Tue May 17, 2011 5:21 pm

MT,

Totally agree... I think of cash and gold especially as having those traits.  Gold because you want some physical, but it can eventually become a hassle, and cash because there are some near-perfect-cash items out there that really are a lot of bang-for-your-buck risk/reward wise.
Last edited by moda0306 on Tue May 17, 2011 5:23 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by fnord123 » Tue May 17, 2011 5:41 pm

moda0306 wrote:http://www.treasurydirect.gov/indiv/res ... dterms.htm

Interest is compounded within EE bonds, it would appear.  The 1.1% appears, given the terms, to be compounded, and the 3.53%, I'm quite sure, is a compounded calculation of what it would take to double your money in 20 years.
Whoops, you are right - thanks for the correction!  Given the tax deferred nature of EE-bond interest, then they definitely provide a better rate of return at identical interest rates.
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Re: EE Series Savings Bonds

Post by Lone Wolf » Wed May 18, 2011 10:26 am

moda0306 wrote: You killed my dreams of getting 1.1% AND the doubling to achieve a 4.6% rate... that killed me.
I feel awful about killing your dreams but the good news is that your analysis still holds up.  If interest rates stay really low, you are getting a "free roll" option at 20-year 3.5% rates.  If they go up, you can just redeem the EE's and throw the cash you raise into new savings bonds, T-bills, or your Treasury ladder.
moda0306 wrote: Further, comparing fixed i-bond rates and fixed ee bond rates is also somewhat interesting (see above links).  EE's historically offer much more lucrative fixed rates, but the thing is, when those rates are fixed at or near 3.5%, the doubling is almost a moot point.  Only as rates lower does that feature tend to stand out. 
Yes!  The "doubling" feature was only added in May 2005, and the fixed rate wasn't substantially below 3.5% until May 2008.  This shows that a) the doubling feature has only become relevant in the past couple of years and b) they change the rules on newly-issued savings bonds all the time.
MediumTex wrote: For the cash piece, I view savings bonds as deep storage items.  I would try to configure a PP with savings bonds so that you will never have to sell any of your bonds to rebalance.  This probably results in a savings bond target of 20-30% of your cash PP holdings.
I very nearly 100% agree with everything you've said, as it is excellent general advice about the PP.  I do believe that EE bonds could be an exception, though.  EE bonds at 1.1% enjoy a superior rate of interest to even a 3-year Treasury.  You must hold them for one year.  After that, though, they can be redeemed at any time, with the only risk being 3 months of interest.  With rates low, you want to hang on to them.  If rates rise substantially, though, I think you must be willing to pull them out of the freezer and redeem them.
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Re: EE Series Savings Bonds

Post by moda0306 » Wed May 18, 2011 10:36 am

I think what MT was saying that as long as the rates stay competetive, "redeem" MM and other cash first before sinking down to some preferable-termed I or EE bonds.

I don't think he was suggesting you sit on your 0% fixed i bond if there are 2% fixed being issued.

Basically, if rates make already-owned i-bond or ee-bond particularly attractive, they should sit "deep" in your cash holdings... maybe "redeemed cash of last resort," if you will.

I'm sure we're in agreement on all this, just wanted to clarify.

One question maybe should be... How much time do we get before they start changing terms on these bonds.  Do they announce it 6-12 months in advance, or is it a "November 1st" announcement that they're changing the bonds that are offered to the public?  This could play into planning a bit.  I'm surprised EE bonds still exist as they did in 2005, to be honest.
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Re: EE Series Savings Bonds

Post by moda0306 » Wed May 18, 2011 10:47 am

One quick point I've already made about these, but is worth repeating for tinkerers, is that you gain nothing by purchasing these bonds before the last day of the month by redeeming them beyond the first day of the month. 

The interest is calculated as if you owned the bond the whole month.
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Re: EE Series Savings Bonds

Post by moda0306 » Thu May 19, 2011 5:52 pm

I've been thinking of EE bonds as always lying within your cash portion, but here's a bit of an EE bond "trick" you may want to consider if rates tumble back to their 2008 levels:

Normally, one my not be inclined to buy EE bonds, but near the end of 2008, a PP holder would have been sitting on 20-30 year bonds yielding 3%-2.6% (rates were actually higher on 20's than 30's).  At this point, if one had deep enough funds in their LTT holdings to purchase some EE bonds without risk of skewing the liquidity of their portfolio too much, it may have been a GREAT time to do that.  The EE bond has the phantom, tax-deferred unredeemable 3.53% interest for holding it for 20 years, which handily beat the 2.6-3% taxable return of the 20-30 year bonds at the time.

Treasuries dropped 21% in 2009, but if one would have sold an extra $20,000 of treasuries at the end of 2008 and another $20,000 at the beginning of 2009, to buy $40,000 of EE bonds when rates were obviously very favorable to that decision (3.53% phantom gain on EE bonds held for 20 years), one would have been able to avoid $8,400 in losses.

I know this is all in hindsight, but as long as your funds are deep enough and liquid enough, the advantages of diving into unredeemable 20-year treasury at a tax-deferred 3.53% at that time, at least to some degree, even if less than $40,000, would have been huge, even if rates would have continued to fall.

I realize that a huge part of the reason for investing in LTT's is the price moves, not just the interest payment, but as MT has said, much like physical gold lies deep within your gold reserves and will most likely not be sold, EE bonds within cash or LT bonds (or a mix of both as st & lt rates make different portions of the EE bonds more/less attractive) can sit deep within those accounts as well.

The EE bonds as a LT bond definitely does have some drawbacks, just as a gold etf doesn't have all the traits you want in an inflation hedge, but one can avoid a lot of interest rate risk if they bury these suckers deep in their LTT holdings at the right time.  Let's just hope if rates drop again they don't weaken the EE bond from its current form.

One more consideration is that usually you are selling bonds at 20 years in duration... so if rates go low, and continue to stay low so that you're holding your EE's for the 20 year doubling, you might want to start to view those bonds as somewhat split between cash and bonds... as realistically that's more what will be comparable to... no big deal.  Lastly, you probably will have tax considerations with all of this, often not favorable to selling a bunch of bonds at a gain to invest in a similar instrument.  Just keep all of this in mind.
Last edited by moda0306 on Thu May 19, 2011 6:03 pm, edited 1 time in total.
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Re: EE Series Savings Bonds

Post by moda0306 » Thu May 19, 2011 6:11 pm

One way out of selling LT bonds just to buy EE bonds as part of your LTT portion is to sell your LT bonds to cash (hopefully in a tax-deferred account), and simply "convert" your EE bonds to LTT's... basically, take whatever your balance is of EE bonds, and instead of considering it cash, consider it LTT's, and the funds from selling your LTT's will stay in your account as cash.

Of course, you can always try to buy additional EE bonds as you see fit and as liquidity allows.
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