What's the role of EE bonds?

[AndroAsc]

I've read about EE bonds, and I'm trying to figure out how they fit into one's portfolio. Here's what I've gathered. Please correct me if I am wrong.
1) EE bonds have fixed interest rate that is pegged to intermediate-term treasuries, and it is updated semiannually, so they could fill in the role of intermediate-term bond funds.
2) EE bonds have a tax-deferred mechanism like i-Bonds, so they make sense for people who have little tax-deferred space and don't want to get too heavy on municipal bonds.
3) EE bonds have a guaranteed rate of 3.5% p.a. from 0 to 20 years, on the condition that is only redeemed on the 20th year or later.
4) EE bonds earn interest for up to 30 years.

Did I get anything incorrect or missed out something important?

EDIT: The use of EE bonds seems to be the "i-Bond equivalent to TIPS" for normal bond funds. So it may be good for people with very little tax-deferred space and are unwilling to go 100% munis.

[beareconomy]

I'm not sure if there is a role for them. The only thing I could think of is after 20 years, you could possibly use them for college tuition for a tax break maybe? I'm not sure about this. Then that 3.5% guaranteed is not really that bad of an idea.

[DavidC]

I've read about EE bonds, and I'm trying to figure out how they fit into one's portfolio. Here's what I've gathered. Please correct me if I am wrong.
1) EE bonds have fixed interest rate that is pegged to intermediate-term treasuries, and it is updated semiannually, so they could fill in the role of intermediate-term bond funds

Hmm... you seem to be describing the older EE bonds here rather than the newer ones. This is how the rate for new EE bonds rates are set:

EE Bonds issued May 2005 and after earn a fixed rate of interest. The fixed rate is determined by adjusting the market yields of the 10-year Treasury Note by the value of components unique to savings bonds, including early redemption and tax deferral options.

Note that this means that the current low 0.6% APY rate will apply to currently issued bonds up to 19 years and 11 months from now with a one-time bump at 20 years.

• Bond held 5 years... 0.6% APY
• ...
• Bond held 19 years 11 months... 0.6% APY
• Bond held 20 years... ~3.5% APY
• Bond held 20 years 1 month... ?

2) EE bonds have a tax-deferred mechanism like i-Bonds, so they make sense for people who have little tax-deferred space and don't want to get too heavy on municipal bonds.
3) EE bonds have a guaranteed rate of 3.5% p.a. from 0 to 20 years, on the condition that is only redeemed on the 20th year or later.

Yes, as mentioned elsewhere holding these bonds to the 20 year mark is the only real way to make any serious interest on them.

4) EE bonds earn interest for up to 30 years.

Yes although we won't know the interest rate the treasury will pay for those last 10 years (years 20 thru 30).

Did I get anything incorrect or missed out something important?

Just remember the 3 month interest penalty for bonds redeemed before 5 years... although the current 0.6% APY rate isn't exactly going to cost a lot of interest.

For what it's worth Stagflationary Mark and myself provided a cautious recommendation to purchase EE bonds available from May to October 2011 when the rate was 1.1% APY. It's hard for me to get excited about the current 0.6% APY although if the rate on online savings accounts keeps dropping...

[AndroAsc]

Woah... let me confirm, the EE bonds rates are FIXED throughout the life of the bond (analogous to how i-Bonds fixed rate do not change)?

If this is the case, then EE bonds would not make sense unless the fixed rate upon issuance is greater than 3.5%?

[Mel Lindauer]

Woah... let me confirm, the EE bonds rates are FIXED throughout the life of the bond (analogous to how i-Bonds fixed rate do not change)?

If this is the case, then EE bonds would not make sense unless the fixed rate upon issuance is greater than 3.5%?

While the low fixed rate on the EE Bond applies for those who hold for less than 20 years, if you hold for 20 years, you'll get the 3.5% p.a. for the entire 20-year period. So the fixed rate isn't the determinant; the holding period is.

[AndroAsc]

While the low fixed rate on the EE Bond applies for those who hold for less than 20 years, if you hold for 20 years, you'll get the 3.5% p.a. for the entire 20-year period. So the fixed rate isn't the determinant; the holding period is.

Ok, so why then would people buy EE bonds now if their rates are fixed (except for the 20 year mark)? I was thinking of two scenario:
1) Treasury bonds interest rates remain low for the next 20 years -> EE bonds win at 20th year cause it is guaranteed at 3.5%.
2) Treasury bonds interest rate move higher and remain above 3.5% for the next 20 years -> EE bond rates adjust upwards accordingly to track new treasury rates.

So, am I right to say that option (2) is not correct? That even if treasury bond rates go up, EE bond rates will remain fixed at the issued rate? That to me is a real deal killer, cause one would need to be extremely confident that the composite return for treasuries for the next 2 decades will not exceed 3.5%.

[DavidC]

Ok, so why then would people buy EE bonds now if their rates are fixed (except for the 20 year mark)? I was thinking of two scenario:
1) Treasury bonds interest rates remain low for the next 20 years -> EE bonds win at 20th year cause it is guaranteed at 3.5%.
2) Treasury bonds interest rate move higher and remain above 3.5% for the next 20 years -> EE bond rates adjust upwards accordingly to track new treasury rates.

So, am I right to say that option (2) is not correct? That even if treasury bond rates go up, EE bond rates will remain fixed at the issued rate? That to me is a real deal killer, cause one would need to be extremely confident that the composite return for treasuries for the next 2 decades will not exceed 3.5%.

Correct, the return of EE savings bonds issued in May 2005 and later would remain the same (no increase). Remember though that unlike normal treasuries, savings bonds can always be redeemed (even with the 3 month penalty before 5 years) early and the proceeds could be used to purchase whatever is now earning more (treasury bonds, new EE savings bonds, I savings bonds, CDs, etc.)

[grok87]

Here are my thoughts:
(from a previous post)

viewtopic.php?f=10&t=84168


I'm not really a fan of EE Savings Bonds I'm afraid, at least not in their current fixed rate form. I have some of the older ones that pay a variable rate. Those I think could be a nice hedge against higher interest rates- i.e. if interest rates rise my other bond investments will take a hit but those variable rate EE bonds will start to shine...


Let's go over some of the features of EE bonds and how they might compare to an FDIC insured savings account.

1) 1.1% fixed rate
2) tax deferred
3) can't cash in for one year, for first 5 years can cash in and lose 3 months interest, after that can cash in without penalty
4) double in value if held for 20 years which works out to a 3.5% rate of interest

Let's take these features in turn
1) similar rates are available form online savings account. See this list for instance
http://www.depositaccounts.com/savings/
and of course these rates may go up in the future whereas with EE bonds you are stuck with that same 1.1% rate forever (unless you cash in early- more on that below).

2) with a rate that low the tax deferral isn't worth very much. Let's look at a holding period of 10 years. If you start with 10,000 and compound tax deferred at 1.1% and then cash after 10 years then you will have $10,867 assuming a 25% tax bracket. That works out to an after tax annual rate of return of 0.835%. If instead you have a taxable savings account with the same 1.1% rate then you will compound at a lower rate of 0.825% and end up with $10,856- basically the same, just $11 dollars less or a dollar per year!

3) to me the one year freeze and early withdrawal penalties are more important. FDIC savings accounts don't have any of these issues. Why encumber your savings with restrictions and penalties for an extra $1 per year on $10,000 of savings.

4) Now we get to the real point of your question- the doubling after 20 years. The problem is that's a long time to tie up your money. Who knows what might happen in that 20 year period. Let me paint for you the sort of scenario I worry about with this sort of thing:

a) you buy a EE savings bond yielding 1.1% but plan to hold for 20 years to get the 3.5%

b) a couple of years down the road the economy recovers, savings accounts start paying 2-3%

c) you're tempted to cash in your EE savings bonds and switch to a savings account. But you're still lured by the promise of that 3.5% after 20 years. So you don't.

d) then 10 years later rate really take off. savings accounts are now paying 6% or so. You're really tempted to cash in the EE bonds to grab that 6% rate. But then someone points out to you that if you cash in now (after earning 1.1% for 10 years) then you will need to get 6% for the next 10 years to average out to the 3.5% rate from holding the EE bonds for the 20 year doubling period. So you do nothing.

e) 5 years later rates really take off again. There is high inflation, a repeat of the 70s and savings accounts are yielding 10%. You can see where I'm heading with this now right? THe same guy points out to you that if you cash in those EE bonds now, after earning 1.1% for 15 years, then you will need savings accounts rates to stay at 10% for the next 5 years to average out to that 3.5% rate holding the EE bonds for the 20 year doubling period. So you do nothing.

f) then a few years later something bad happens. You die and your husband cashes in the bonds early. Or you get sick or laid off and need the money so you cash in early. The 3.5% goes up in smoke. And you missed out on all those higher savings rates, the 2-3% rates, the 6% rates and the 10% rates.

All this is a long winded way of saying that optionality is really important. You want products that have good optionality, like mortgages you can pay off early, or CDs you can cash in early with cheap penalties so you can invest at higher rates if you want to. You don't want the "bad optionality" that comes from having to hold EE bonds for 20 years to get that 3.5% rate,

hope that wasn't too longwinded

cheers,

[DavidC]

Here are my thoughts:
(from a previous post)

viewtopic.php?f=10&t=84168

...

All this is a long winded way of saying that optionality is really important. You want products that have good optionality, like mortgages you can pay off early, or CDs you can cash in early with cheap penalties so you can invest at higher rates if you want to. You don't want the "bad optionality" that comes from having to hold EE bonds for 20 years to get that 3.5% rate,

hope that wasn't too longwinded

cheers,

It's a great post (I read the original when it came out) and this is why personally I think there are only two real reasons to purchase current EE bonds:

1. You are satisfied with that 3.5% over 20 years and nothing short of an emergency where you really need the cash will persuade you to cash out early
2. The fixed rate is good enough for whatever reason currently (better than current savings accounts, etc.) and you intend to bail out whenever rates on savings accounts/future EE bonds/whatever improve in the future

For whatever it's worth I'm in the second camp with my October 2010 (1.4% APY) and 2011 (1.1% APY) bonds. Interest rates would have to remain very low for me to hold them for 20 years in which case we may have worse things to worry about than EE bonds...

[grok87]

Here are my thoughts:
(from a previous post)

viewtopic.php?f=10&t=84168

...

All this is a long winded way of saying that optionality is really important. You want products that have good optionality, like mortgages you can pay off early, or CDs you can cash in early with cheap penalties so you can invest at higher rates if you want to. You don't want the "bad optionality" that comes from having to hold EE bonds for 20 years to get that 3.5% rate,

hope that wasn't too longwinded

cheers,

It's a great post (I read the original when it came out) and this is why personally I think there are only two real reasons to purchase current EE bonds:

1. You are satisfied with that 3.5% over 20 years and nothing short of an emergency where you really need the cash will persuade you to cash out early
2. The fixed rate is good enough for whatever reason currently (better than current savings accounts, etc.) and you intend to bail out whenever rates on savings accounts/future EE bonds/whatever improve in the future

For whatever it's worth I'm in the second camp with my October 2010 (1.4% APY) and 2011 (1.1% APY) bonds. Interest rates would have to remain very low for me to hold them for 20 years in which case we may have worse things to worry about than EE bonds...

Thanks David,
Have you considered 7 year Pen Fed CDs yielding 2.75%? You can cash in early and lose just 1 years interest (less if you have held less than 1 year)
I think technically they can make you give 60 days written notice- not aware that they are doing that now..
cheers,