EE Bonds for the Accumulation Phase

[Storm]

Hi Moda,

I was thinking about this, and even for those of us in accumulation phase, I don't think EE bonds are a good idea to replace 30 year notes.  The main reason is that during accumulation, I use the position of various assets to choose what to buy next.  For example, 30 year bonds are way up, so I'll buy more gold or stocks, etc.  Since EE bonds don't appreciate in value so dramatically during a deflationary event, this throws off my buy signal and I might end up acquiring more EE bonds when I should be buying stocks or gold.

Even though we might never sell our long bonds until we are in drawdown phase, the mere fact that they are over 25% means I don't need to buy any more, and can be considered somewhat like a mini-rebalance, if that makes sense.

[moda0306]

Storm,

What I suggest to "fix" that problem isn't perfect, but here goes....

Since the first problem is the shorter duration, if you buy $5k of EE's, maybe allocate 1/5 of them as deep cash, and 4/5 as deep bonds.  The cash value piece will be $1,000, and the $4,000 in bonds will actually be valued at whatever Investopedia says they're worth based on a similar marketable security, initially, for the purposes of your analysis.

http://www.investopedia.com/calculator/ ... z1iPFx7F3p

Then, since these aren't marketable securities, and must, in fact, be held to original maturity, you could help yourself sleep at night by simply taking that "Investopedia value" and average it with its "face value."

In effect, you've counted some as cash to counter the shorter duration, figured out what the bond portion's FMV should be, but then decided to pull that back a bit for "lack of marketability."

I think this is the best way to help you in your situation... May sound a bit messy, but if you think through it a couple times it'll get really easy... trust me.

[Storm]

I'm not sure I follow... say I buy $5,000 worth of EE bonds...  $5,000 worth of TLT goes up to $7500, but my EE bonds are only worth $5200... what do I buy next?

[moda0306]

If TLT went up 50%, your EE bonds would be "worth" (FMV per bond calculator) much more than $5,200.  Currently, I think $5k in EE bonds is worth about $5,600, if you assume it's a marketable instrument that accrues interest at 3.53% for 20 years.  Of course, there's value to be had with its lack of interest rate risk, but value lost due to lack of marketability.  My argument is, if used in the right doses, the penalty for lack of marketability is small, but the lack of interest rate risk could prove extremely helpful.

If TLT went up 50%, you are probably in a position to be buying other, non-LTT, assets.  If some of that is in the form of EE bonds, you could simply look at those bonds value as you've quasi-calculated based on a similar marketable security, and rebalance (or load up on other assets) based on that implied value.

Maybe somebody else can help me here... I don't think I know how else to explain it.  Maybe you could pose your question a different way and it'll click with me.

[MachineGhost]

So, EE has a virtual value that would go up in disinflation.  But, wouldn't the same logic also apply to I bonds, even though neither EE or I can't actually be sold in the secondary market to "realize" the virtual gain to be able to reallocate the $ into other asset classes?  It still seems more like "cash" than a LT bond to me.

On EE it appears that you actually earn a fixed rate of interest set every 6 months which I was confusing with the CPI adjustment of I bonds.  So technically you are earning 100%^(1/20) annually plus the fixed rate of interest for paper EE bonds.  That seems like a smart deal if you know for sure that inflation will be lower than the combined rate over the next 20 years, but why is that superior to to buying I bonds where the inflation risk is removed, unless you've hit the per SSN capacity max?

It does seem like an opportunity is closing if paper EE is being phased out as electronic EE is face value only, i.e. no 100% gain in 20 years from buying at 50% off.  At least not until after 2012 judging by your customer service response.

MG

If TLT went up 50%, your EE bonds would be "worth" (FMV per bond calculator) much more than $5,200.  Currently, I think $5k in EE bonds is worth about $5,600, if you assume it's a marketable instrument that accrues interest at 3.53% for 20 years.  Of course, there's value to be had with its lack of interest rate risk, but value lost due to lack of marketability.  My argument is, if used in the right doses, the penalty for lack of marketability is small, but the lack of interest rate risk could prove extremely helpful.

If TLT went up 50%, you are probably in a position to be buying other, non-LTT, assets.  If some of that is in the form of EE bonds, you could simply look at those bonds value as you've quasi-calculated based on a similar marketable security, and rebalance (or load up on other assets) based on that implied value.

Maybe somebody else can help me here... I don't think I know how else to explain it.  Maybe you could pose your question a different way and it'll click with me.

[moda0306]

MG,

No opportunity is closing any time soon.  The 20-year doubling is still in tact.  I double checked on this.

The point about i-bonds is if you buy them today they're guaranteed to track inflation, and nothing more.  They could very likely return much less than 3.5% compounded over the next 20 years.  The whole point of LT bonds is that they are a promise to pay for a LONG time.  I bonds can be redeemed at any time for their calculated value, so I'm not sure where you're getting that they're not marketable.  EE bonds are the only ones where you have to sit on your hands to get the 20-year doubling.

EE bonds are a guarantee to double in value.  This makes them pretty good for deflation protection, but not that good if inflation kicks in again.

We saw a great year for i-bonds, but I'd hardly expect for that to repeat itself.  The last two months of CPI calc have been negative, and I'm not sure December will be otherwise.  I highly doubt we'll see 3.5% inflation year after year, at least in the next decade.

For the record, I DO like I-bonds, and probably even better than EE bonds, but EE bonds have a special place with their guaranteed doubling.  This makes them very good during an extended deflationary recession, where returns on everything seem pathetic.  If Japan had I-bonds and EE-bonds back in 1990, the EE holder would be in a great place compared to I-bonds. 

I even think if you run out of i-bonds, EE bonds are good for cash as well... even their measly .6% is better than treasury bills right now.  But in the end, EE bonds are good leveraged (long-term interest promise) deflation protection for an accumulator, and have the added bonus of having zero interest-rate risk, but at the price of non-marketability.  I think that can be safely worked into an investor's PP in the proper doses.

[Storm]

If TLT went up 50%, your EE bonds would be "worth" (FMV per bond calculator) much more than $5,200.  Currently, I think $5k in EE bonds is worth about $5,600, if you assume it's a marketable instrument that accrues interest at 3.53% for 20 years. 

Right, I see that in a period of deflation, EE bonds increase in relative value to other "cash" type instruments, however, because there is no secondary market, there is no way to rebalance them, so I don't think they make a good substitute for 30 year bonds.  Remember, 2008 was a great rebalancing event for LT bonds and really helped the PP to not get hammered so badly like everyone else in the market at the time.

[moda0306]

Storm,

I don't know if you read much of my initial posts, but I covered the rebalancing quandry.

Simply, you only should use EE bonds as a  substitute to LTT's to a moderate degree.  10%?  25%?  50?  Depending on how many months/years of living expenses you have saved up, EE bonds could make up a part of your long-bond portfolio.

Even imagining that 50% of your LTT portion was in EE bonds, if you reached a rebalance band (35/15) where you had to sell LTT's (PS, this is a pretty rare occurence), then your 50% EE bonds would be worth no more than 17.5% of your total portfolio.  This leaves you with 17.5% real LTT's, 10% of which you now have to sell.  Now you have a 17.5%/7.5% EE/LTT split.  Sounds scary, but imagine, again, this rising to rebalance before any other asset... that would mean the EE's would grow to, at max, 24.5%, and the LTT's would grow to 10.5%, once again, giving you enough to rebalance.

The figures are a tad off (but in my favor) since EE's, having a 20-year-or-less duration, will have less price volatility.

Obviously, given this example, 50% EE's will get you to about 2 rebalances before you have just about completely worn out your real LTT balance  Rebalances for long-term bonds, though, are relatively rare, especially for someone in the accumulation stage, not to mention the lack of cash flow is also hardly an issue during that stage.

So while I'm not suggesting as much as 50% of your bonds be EE bonds, it shows that it's unlikely that an accumulator would run into much trouble with that allocation.  The real benefit comes from when yields fly the other way, and your EE bonds haven't dropped in price.

[moda0306]

BUMP.... No particular reason... maybe because 20-year treasuries are yielding about 2.15% right now.

[Greg]

BUMP.... No particular reason... maybe because 20-year treasuries are yielding about 2.15% right now.

I'm still mulling around your idea of holding EE bonds/LTT towards the end of the year. I've just started my PP so I'm about 6k in LTT and 2k in EE bonds. I've been purchasing around a 2-to-1 for LTT to EE bonds to lessen the fact of if there is a interest rate spike. If rates go up, I won't lose as much because 1/3 of the money is in EE bonds. If rates go down I'll still get the capital appreciation from the 2/3 of my Bonds section in LTTs.

We'll just see if we go Japan or Zimbabwe.