ibond vs cd

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tipee
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ibond vs cd

Post by tipee » Thu Apr 13, 2017 6:38 pm

So I purchased 5k of ibonds with my federal tax refund, and then discovered that each person can purchase another 10k per year in ibonds. Given that the interest rate fluctuates (I did a quick calculation of the last 10 years and 10k ended up at 15.7k and change, which is close to a 2% CD over 10 years), is there a good reason to choose ibonds over let's say a 5 year CD, and then another 5 year CD after that? I can't imagine 5 year CD rates falling lower than 2% in 5 years.

Thoughts?

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DaftInvestor
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Re: ibond vs cd

Post by DaftInvestor » Thu Apr 13, 2017 6:39 pm

Deferring taxes is one reason.

aristotelian
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Re: ibond vs cd

Post by aristotelian » Thu Apr 13, 2017 7:38 pm

I-Bonds are liquid after a year. So you get the 5-year CD rate with only one year time commitment. If inflation goes down, then maybe the CD makes sense.

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Re: ibond vs cd

Post by masteraleph » Thu Apr 13, 2017 7:40 pm

1) Deferred federal income tax (depending on your income and whether you have educational expenses to pay, possibly entirely negated federally income tax, but that's probably not true of most folks who can buy $10k per year in ibonds).

2) No state tax. Could be valuable for you or not- living in NYC, that adds more than 10% to my effective return, so that 2% becomes an effective 2.2%.

3) Inflation protection. Keep in mind that we've had very low inflation for the last 10 years- you're basically starting a year or so prior to the recession. Will inflation be as low for the next 10 years?

4) Standardized penalty. Once you hit a year of holding the bond, you know what the penalty will be if you sell it (3 months). Once you hit 5 years, there is no penalty. What if you take out a CD for 5 years, then another one, and in year 7 you need the money?

None of this is a guarantee that you'll win with ibonds- just food for thought.

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Re: ibond vs cd

Post by Mel Lindauer » Thu Apr 13, 2017 7:51 pm

masteraleph wrote:1) Deferred federal income tax (depending on your income and whether you have educational expenses to pay, possibly entirely negated federally income tax, but that's probably not true of most folks who can buy $10k per year in ibonds).

2) No state tax. Could be valuable for you or not- living in NYC, that adds more than 10% to my effective return, so that 2% becomes an effective 2.2%.

3) Inflation protection. Keep in mind that we've had very low inflation for the last 10 years- you're basically starting a year or so prior to the recession. Will inflation be as low for the next 10 years?

4) Standardized penalty. Once you hit a year of holding the bond, you know what the penalty will be if you sell it (3 months). Once you hit 5 years, there is no penalty. What if you take out a CD for 5 years, then another one, and in year 7 you need the money?

None of this is a guarantee that you'll win with ibonds- just food for thought.
A very good summary of the benefits of I Bonds.
Best Regards - Mel | | Semper Fi

tipee
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Re: ibond vs cd

Post by tipee » Thu Apr 13, 2017 8:25 pm

masteraleph wrote:1) Deferred federal income tax (depending on your income and whether you have educational expenses to pay, possibly entirely negated federally income tax, but that's probably not true of most folks who can buy $10k per year in ibonds).

2) No state tax. Could be valuable for you or not- living in NYC, that adds more than 10% to my effective return, so that 2% becomes an effective 2.2%.

3) Inflation protection. Keep in mind that we've had very low inflation for the last 10 years- you're basically starting a year or so prior to the recession. Will inflation be as low for the next 10 years?

4) Standardized penalty. Once you hit a year of holding the bond, you know what the penalty will be if you sell it (3 months). Once you hit 5 years, there is no penalty. What if you take out a CD for 5 years, then another one, and in year 7 you need the money?

None of this is a guarantee that you'll win with ibonds- just food for thought.
Thanks for laying out the facts that will hopefully help me make the decision.

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Re: ibond vs cd

Post by #Cruncher » Thu Apr 13, 2017 10:31 pm

tipee in original post wrote:Given that the interest rate fluctuates (I did a quick calculation of the last 10 years and 10k ended up at 15.7k and change, which is close to a 2% CD over 10 years), is there a good reason to choose ibonds over ...
There are two errors in your parenthetical premise, tipee. But that's really academic since it is the wrong premise.

First, a $10,000 purchase of I Bonds in April 2007 has grown to only $14,028 in April 2017, not $15,700. Second, this is an annual return of 3.4%, not 2% (1.4 = 1.034 ^ 10). But both errors are academic because the I Bond purchased in April 2007 had a 1.4% fixed rate while the one you can buy today has a 0% fixed rate. It is against this latter choice that you should compare the option of buying a CD.
masteraleph in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3326109#p3326109]this post[/url] wrote:4) Standardized penalty. Once you hit a year of holding the bond, you know what the penalty will be if you sell it (3 months).
You know what it will be in months; but not in dollars. For example, consider a $5,000 I Bond with 0.00% Fixed Rate Purchased May 2013. If redeemed in August 2015, the 3-month penalty would be $0 (5144 - 5144). But if redeemed in February 2017, the 3-month penalty would be $36 (5224 - 5188).

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Re: ibond vs cd

Post by whodidntante » Thu Apr 13, 2017 11:51 pm

I-bonds are not great, because you're going to lose money after tax. So you should compare them to other available alternatives. Most of the time you are better off holding a 5 year CD. If inflation spikes and then stays high for years, today's 5 year CDs will not be attractive.

I actively manage my Ibonds. I used to own some but I haven't owned any in a while because they paid next to nothing. I am planning to buy 10k in May. I'll sell that too if they stop paying significant interest.

If you have some with a large fixed rate, hang on to those.

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Re: ibond vs cd

Post by dh » Fri Apr 14, 2017 8:03 am

To help with the comparison...
With today's (April 14, 2017) announced CPI-U, the composite for 0% fixed rate I-Bonds will be 1.96% for the next six months. Obviously, the fix rate will be set for I-Bonds purchased after the end of this month on May 1.

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 8:24 am

dh wrote:To help with the comparison...
With today's (April 14, 2017) announced CPI-U, the composite for 0% fixed rate I-Bonds will be 1.96% for the next six months. Obviously, the fix rate will be set for I-Bonds purchased after the end of this month on May 1.
So that would be almost 4% annualized rate, correct? Versus 5-year CD at CapOne currently getting 2.30%.

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Re: ibond vs cd

Post by dh » Fri Apr 14, 2017 8:36 am

aristotelian wrote:
dh wrote:To help with the comparison...
With today's (April 14, 2017) announced CPI-U, the composite for 0% fixed rate I-Bonds will be 1.96% for the next six months. Obviously, the fix rate will be set for I-Bonds purchased after the end of this month on May 1.
So that would be almost 4% annualized rate, correct? Versus 5-year CD at CapOne currently getting 2.30%.
No way to know--it depends. If we experience a significant decline in the CPI-U and the composite rate in the following 6 month cycle goes to 0%, then you are getting an APR of 1.96% for six months and 0% for six months. If you cashed out after a year, you lose out of the last three months of 0% (hence, you earn a rate of 0.98% for the year).

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Re: ibond vs cd

Post by DaftInvestor » Fri Apr 14, 2017 8:43 am

dh wrote:
aristotelian wrote:
dh wrote:To help with the comparison...
With today's (April 14, 2017) announced CPI-U, the composite for 0% fixed rate I-Bonds will be 1.96% for the next six months. Obviously, the fix rate will be set for I-Bonds purchased after the end of this month on May 1.
So that would be almost 4% annualized rate, correct? Versus 5-year CD at CapOne currently getting 2.30%.
No way to know--it depends. If we experience a significant decline in the CPI-U and the composite rate in the following 6 month cycle goes to 0%, then you are getting an APR of 1.96% for six months and 0% for six months. If you cashed out after a year, you lose out of the last three months of 0% (hence, you earn a rate of 0.98% for the year).
Alternatively if inflation picks up the ibond could further outpace the 5-year CD. You also have to look at this after tax as others have mentioned. If you live in a high-tax state, and don't plan on cashing in until after retirement (and believe you will a lower tax-bracket at that time) - the ibond has further advantages. (OP: Lots of math examples on this in other threads if you take the time to look through them - google search ibond versus CD at the top of this page.)
I believe the bottom line is that we are comparing apples to oranges here in a way - we are comparing a tax-advantaged and inflation protected bond with a fixed-rate CD - to diversify - you could put money in both buckets.

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 8:45 am

dh wrote:
aristotelian wrote:
dh wrote:To help with the comparison...
With today's (April 14, 2017) announced CPI-U, the composite for 0% fixed rate I-Bonds will be 1.96% for the next six months. Obviously, the fix rate will be set for I-Bonds purchased after the end of this month on May 1.
So that would be almost 4% annualized rate, correct? Versus 5-year CD at CapOne currently getting 2.30%.
No way to know--it depends. If we experience a significant decline in the CPI-U and the composite rate in the following 6 month cycle goes to 0%, then you are getting an APR of 1.96% for six months and 0% for six months. If you cashed out after a year, you lose out of the last three months of 0% (hence, you earn a rate of 0.98% for the year).
Thanks. I am just clarifying that the 1.96% is the six-month rate. The rate may change, but the current annualized rate is 3.92%. That would be the best apples-to-apples comparison with prevailing CD rates based on the information we have.

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Re: ibond vs cd

Post by BlueCable » Fri Apr 14, 2017 9:16 am

aristotelian wrote: Thanks. I am just clarifying that the 1.96% is the six-month rate. The rate may change, but the current annualized rate is 3.92%. That would be the best apples-to-apples comparison with prevailing CD rates based on the information we have.
I do not think that is correct. APR is a calculation that tells you how much your principal would appreciate over 12 months. Hopefully someone can confirm. Otherwise, almost all of us would be buying I-Bonds right now.

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 9:30 am

BlueCable wrote:
aristotelian wrote: Thanks. I am just clarifying that the 1.96% is the six-month rate. The rate may change, but the current annualized rate is 3.92%. That would be the best apples-to-apples comparison with prevailing CD rates based on the information we have.
I do not think that is correct. APR is a calculation that tells you how much your principal would appreciate over 12 months. Hopefully someone can confirm. Otherwise, almost all of us would be buying I-Bonds right now.
That is what I am asking. Right now they are earning 2.76% "composite rate" based on 0% fixed rate plus 1.38% semiannual inflation rate. If the semiannual inflation rate has gone up to 1.96%, the composite rate would be 3.92% plus any fixed rate, correct? They are already a good deal, but they would be a great deal if this is correct, especially if CD rates do not increase to compensate.

https://www.treasurydirect.gov/indiv/re ... dterms.htm

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Re: ibond vs cd

Post by dh » Fri Apr 14, 2017 9:31 am

BlueCable wrote:
aristotelian wrote: Thanks. I am just clarifying that the 1.96% is the six-month rate. The rate may change, but the current annualized rate is 3.92%. That would be the best apples-to-apples comparison with prevailing CD rates based on the information we have.
I do not think that is correct. APR is a calculation that tells you how much your principal would appreciate over 12 months. Hopefully someone can confirm. Otherwise, almost all of us would be buying I-Bonds right now.
BlueCable, that is my understanding as well. For a bond purchased 6 months ago at 0% fixed, you earned an APR of 2.76% for six months (through April 30, 2017), and will earn an APR of 1.96% for the next 6 months. Hence, the total APR of that particular I-bond would be the mean (not the sum of those two).

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 9:51 am

dh wrote:
BlueCable wrote:
aristotelian wrote: Thanks. I am just clarifying that the 1.96% is the six-month rate. The rate may change, but the current annualized rate is 3.92%. That would be the best apples-to-apples comparison with prevailing CD rates based on the information we have.
I do not think that is correct. APR is a calculation that tells you how much your principal would appreciate over 12 months. Hopefully someone can confirm. Otherwise, almost all of us would be buying I-Bonds right now.
BlueCable, that is my understanding as well. For a bond purchased 6 months ago at 0% fixed, you earned an APR of 2.76% for six months (through April 30, 2017), and will earn an APR of 1.96% for the next 6 months. Hence, the total APR of that particular I-bond would be the mean (not the sum of those two).
I see. Sorry to confuse everyone. On the T-Direct website what is listed is the "semi-annual inflation rate". So just to confirm, the semi-annual inflation rate is going down to 0.98%?

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Re: ibond vs cd

Post by dh » Fri Apr 14, 2017 10:16 am

aristotelian wrote:
dh wrote:
BlueCable wrote:
aristotelian wrote:

I see. Sorry to confuse everyone. On the T-Direct website what is listed is the "semi-annual inflation rate". So just to confirm, the semi-annual inflation rate is going down to 0.98%?
Not confusing, just a really good thread! I always appreciate these discussions, as I can get off track easily.

September 2016 CPI-U: 241.428
March 2017 CPI-U: 243.801

(243.801-241.428) / 241.428 = 0.98%

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Re: ibond vs cd

Post by Da5id » Fri Apr 14, 2017 10:30 am

dh wrote:
aristotelian wrote:
dh wrote:
BlueCable wrote:
aristotelian wrote:

I see. Sorry to confuse everyone. On the T-Direct website what is listed is the "semi-annual inflation rate". So just to confirm, the semi-annual inflation rate is going down to 0.98%?
Not confusing, just a really good thread! I always appreciate these discussions, as I can get off track easily.

September 2016 CPI-U: 241.428
March 2017 CPI-U: 243.801

(243.801-241.428) / 241.428 = 0.98%
So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?

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Re: ibond vs cd

Post by flamesabers » Fri Apr 14, 2017 10:40 am

Da5id wrote:So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
That's correct. Between the two rates, I'm betting the variable rate will decrease more then what the fixed rate will increase (if at all). Also, you can always check again in November to see what the new fixed rate will be.

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Re: ibond vs cd

Post by Da5id » Fri Apr 14, 2017 10:47 am

flamesabers wrote:
Da5id wrote:So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
That's correct. Between the two rates, I'm betting the variable rate will decrease more then what the fixed rate will increase (if at all). Also, you can always check again in November to see what the new fixed rate will be.
Thanks. For those who actually plan on buying i-bonds this year, I'm curious your plan is?

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 10:51 am

Da5id wrote: So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
You are definitely correct about waiting on the fixed rate. However, I can't imagine that if you bought now that they would give you six months of interest though. Wouldn't it be pro-rated?

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Re: ibond vs cd

Post by flamesabers » Fri Apr 14, 2017 10:54 am

Da5id wrote:
flamesabers wrote:
Da5id wrote:So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
That's correct. Between the two rates, I'm betting the variable rate will decrease more then what the fixed rate will increase (if at all). Also, you can always check again in November to see what the new fixed rate will be.
Thanks. For those who actually plan on buying i-bonds this year, I'm curious your plan is?
I'll probably buy more I-Bonds this month to get the higher variable rate. I'm not sure if I'll even get $10k of I-Bonds this year since I'm striving to max out my 401k contributions for the first time this year. If I had the extra cash to invest, I would max out on I-Bonds this month. If fixed rates increase next month, I figure they'll increase again or stay the same in November, at which point I can buy them at the new fixed rate in January 2018.

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Re: ibond vs cd

Post by Da5id » Fri Apr 14, 2017 11:05 am

aristotelian wrote:
Da5id wrote: So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
You are definitely correct about waiting on the fixed rate. However, I can't imagine that if you bought now that they would give you six months of interest though. Wouldn't it be pro-rated?
If you look here:
it says that the rate changes for a bond purchased in April on "April 1 and October 1". So unless I misunderstand, if you buy now you get the current higher variable rate until October.

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Re: ibond vs cd

Post by aristotelian » Fri Apr 14, 2017 11:10 am

Da5id wrote:
aristotelian wrote:
Da5id wrote: So if you buy an i-bond before end of month, fixed rate will be 0%, composite rate will be 2.76% (annually) until October. If you buy in May, fixed rate will be whatever they set it to and composite rate will be new fixed + 1.96% (annually)? So in the buy now vs May camp, it is whether to forego half a years interest at higher rate in hopes that fixed will be non-zero?
You are definitely correct about waiting on the fixed rate. However, I can't imagine that if you bought now that they would give you six months of interest though. Wouldn't it be pro-rated?
If you look here:
it says that the rate changes for a bond purchased in April on "April 1 and October 1". So unless I misunderstand, if you buy now you get the current higher variable rate until October.
I see, thanks again!

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Re: ibond vs cd

Post by traveltoomuch » Fri Apr 14, 2017 11:15 am

Da5id wrote:For those who actually plan on buying i-bonds this year, I'm curious your plan is?
I'm leaning toward "buy now" with the assumption that I'll likely cash it in at the 12 or 15 month point. Here's a writer whose thoughts I like:

https://seekingalpha.com/article/406247 ... cent-may-1

He's speculating that we won't see a fixed rate above .1%.

Buying in April, cashing at 12 mo. will give 1.87% total interest (ignoring compounding and ignoring the 11-month magic of I-bonds.). Cashing at 15 mo. will give 2.36% total interest (same simplifications), or an annualized 1.89%. That easily beats every 12-15 mo. CD I'm finding, though the money is firmly tied up for 12 months.
Last edited by traveltoomuch on Fri Apr 14, 2017 11:51 am, edited 1 time in total.

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Re: ibond vs cd

Post by Kevin M » Fri Apr 14, 2017 11:15 am

I Bonds give you more certainty in real terms for a longer time period: you will earn 0% real for up to 30 years. This does not factor in state tax deduction (if any), tax deferral benefit (if any), or deduction for qualified education expenses (if any), or penalty if withdrawn within five years (if any).

A good CD gives you more certainty in nominal terms for a shorter period. Until recently you could get a 7-year CD at 3% with an early withdrawal penalty (EWP) of six months of interest. The best 5-year CD currently available nationwide is 2.75% with EWP of one year of interest, but I think that deal ends today.

Doing some of each hedges your bets.

One thing that some people consider a negative, that hasn't been mentioned, is the need to use a TreasuryDirect account for electronic purchases (other than the tax refund deal). Even I Bond enthusiast Mel considers this such a negative that he won't buy I Bonds through Treasury Direct.

Another point that should be mentioned is that you can by $10K of I Bonds each year in the name of a trust, so that's $20K for an individual with a living trust, or $30K for a couple with a living trust, or $40K for a couple with two living trusts. I bought $10K/year as an individual and $10K in the name of my living trust for a few years, but didn't do so last year, and so far have no plans to do so this year.

I did buy some of the 7-year CDs at 3% though, which have an expected real return of about 1% if you go buy breakeven 7-year inflation rate of less than 2% and/or Fed inflation target of 2%. Of course there is uncertainty in the real return, but given the option to do an early withdrawal at a cost of only 1.5%, I like the odds. I also like that I could buy a lot more than $20K and stay within FDIC/NCUA insurance limits (up to $250K in an IRA, and up to $1.25M in taxable with five beneficiaries).

If you plan to hold five years or more, you should consider TIPS over I Bonds, since real return is greater than 0%. This is especially true if you have space in a tax-advantaged account, but even in a taxable account (without the tax deferral), you could end up better off with TIPS. I like good direct CDs better than TIPS though.

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Re: ibond vs cd

Post by NancyABQ » Fri Apr 14, 2017 5:22 pm

Da5id wrote: Thanks. For those who actually plan on buying i-bonds this year, I'm curious your plan is?
I just put in my order for $10K to be purchased at the end of April. I'd rather get the 6 months at 2.76% interest than worry about whether the fixed part might go up by 0.1% or something in May (or whether the whole deal might look better in October).

The I-Bonds are part of my fixed income/cash allotment, but they are a long term in investment. I am not concerned with the 1 year of 5 year withdrawal/penalty issues.

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Re: ibond vs cd

Post by Kevin M » Fri Apr 14, 2017 7:53 pm

NancyABQ wrote: I just put in my order for $10K to be purchased at the end of April. I'd rather get the 6 months at 2.76% interest than worry about whether the fixed part might go up by 0.1% or something in May (or whether the whole deal might look better in October).
This makes sense, as a relatively short-term investment.
The I-Bonds are part of my fixed income/cash allotment, but they are a long term in investment. I am not concerned with the 1 year of 5 year withdrawal/penalty issues.
This does not make as much sense. If you plan to hold long term, you are better off with TIPS, since TIPS have a positive real rate if you go out to five years and beyond. With I Bonds bought now, you are stuck with 0% real. The main advantage of I Bonds is low term risk, but this only is a benefit if real rates increase, and you sell your 0% I Bonds to buy higher yielding I Bonds. But then you lose the "tax advantaged space" of your original I Bond purchase.

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Re: ibond vs cd

Post by NancyABQ » Fri Apr 14, 2017 8:26 pm

Kevin M wrote:
The I-Bonds are part of my fixed income/cash allotment, but they are a long term in investment. I am not concerned with the 1 year of 5 year withdrawal/penalty issues.
This does not make as much sense. If you plan to hold long term, you are better off with TIPS, since TIPS have a positive real rate if you go out to five years and beyond. With I Bonds bought now, you are stuck with 0% real. The main advantage of I Bonds is low term risk, but this only is a benefit if real rates increase, and you sell your 0% I Bonds to buy higher yielding I Bonds. But then you lose the "tax advantaged space" of your original I Bond purchase.
Kevin
I understand what you're saying, but I'm okay with it for now. I said "long term", but I really just meant they are not part of my emergency fund or anything, so it is unlikely I would suddenly need to redeem them at a penalty. In future I will watch the rates, and if the fixed component is higher in some future year, and I don't plan to buy the $10K allotment with new funds, then it will make sense to sell the 0 fixed rate ones to "upgrade". The tax deferral is nice, but not enough of a factor to affect that decision for me.

I am fortunate that I bought a bunch of I-bonds through an employer bond purchase plan, back in ~2003-2006. Those all pay ~1.00%+ fixed rate, so they are looking pretty nice right now. I certainly will be holding on to those! Unfortunately it's only about $18K in original purchase price (worth about $28K now), as I wasn't quite savvy enough to buy the maximum annual amount back then.

I will look into TIPS again, but after my last investigation I had decided a TIPS ladder didn't make sense for me, so it would just be a mutual fund/ETF, which I can buy any time, at any amount, in my IRA.

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Kevin M
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Re: ibond vs cd

Post by Kevin M » Sat Apr 15, 2017 12:36 pm

NancyABQ wrote: I am fortunate that I bought a bunch of I-bonds through an employer bond purchase plan, back in ~2003-2006. Those all pay ~1.00%+ fixed rate, so they are looking pretty nice right now. I certainly will be holding on to those! Unfortunately it's only about $18K in original purchase price (worth about $28K now), as I wasn't quite savvy enough to buy the maximum annual amount back then.
This is provides a good example of how TIPS earn more if held long term. In Jan 2003 you could have bought a TIPS maturing in about 26 years with a yield of 2.74%, so that would have earned 2.74 times as much as the I Bond at 1% if held to maturity. If cashed out now it would have earned even more, due to the price increase with falling real yields.

During the entire period that you bought these I Bonds, 2003-2007, you usually could have bought the TIPS maturing 4/15/2029 at a yield above 2%, with the lowest yield at 1.7% in June 2005. So that's a minimum of 2X the I Bonds if held to maturity (unless you bought the TIPS only at the worst possible times), and more if priced now.

For example, this TIPS, maturing 4/15/2029 with coupon rate 3 7/8%, purchased on 4/14/2003 at a yield of 2.79% (price 119.97) would be worth 139.97 at current yield of 0.45%. So that's a capital gain of about 17% on top of having received the 3 7/8% annual coupon payments with inflation adjustments. Maybe one of the TIPS gurus can crunch the numbers and tell us what the total return would have been, but it obviously would have been a lot more than that I Bond at 1% with no price appreciation.

Image

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Re: ibond vs cd

Post by NancyABQ » Sat Apr 15, 2017 12:54 pm

Kevin M wrote:
NancyABQ wrote: I am fortunate that I bought a bunch of I-bonds through an employer bond purchase plan, back in ~2003-2006. Those all pay ~1.00%+ fixed rate, so they are looking pretty nice right now. I certainly will be holding on to those! Unfortunately it's only about $18K in original purchase price (worth about $28K now), as I wasn't quite savvy enough to buy the maximum annual amount back then.
This is provides a good example of how TIPS earn more if held long term. In Jan 2003 you could have bought a TIPS maturing in about 26 years with a yield of 2.74%, so that would have earned 2.74 times as much as the I Bond at 1% if held to maturity. If cashed out now it would have earned even more, due to the price increase with falling real yields.

During the entire period that you bought these I Bonds, 2003-2007, you usually could have bought the TIPS maturing 4/15/2029 at a yield above 2%, with the lowest yield at 1.7% in June 2005. So that's a minimum of 2X the I Bonds if held to maturity (unless you bought the TIPS only at the worst possible times), and more if priced now.
But hind-sight is 20/20? I had never heard of tips in 2003... (I had never heard of them until 2016!).

I find TIPS a bit difficult to wrap my head around, but I will look into it a bit more. I know there is an upcoming (this week) 5-year TIPS auction ?

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Re: ibond vs cd

Post by Kevin M » Sat Apr 15, 2017 1:48 pm

NancyABQ wrote: But hind-sight is 20/20? I had never heard of tips in 2003... (I had never heard of them until 2016!).
The point is not the hindsight, but using the historical example to help understand why TIPS could be a better investment if purchased today. If you had known about TIPS in 2003, you could have known in advance that would have earned more on a TIPS with a yield of 2.8% than on an I Bond with a yield of 1% if held for 26 years--2.8 times more in real terms.

Now you do know about TIPS. You are saying you plan to hold I Bonds at 0% long term. If by long-term you mean about 30 years, you could recently have bought a 30-year TIPS with a real yield of about 1%. With the I Bond you will have the same purchasing power in 30 years that you have today, while with the TIPS at 1% you'd have about 35% more purchasing power (1.01^30 - 1). This assumes TIPS held in a tax-deferred account, but even in a taxable account you probably would come out better with the TIPS.

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Re: ibond vs cd

Post by NancyABQ » Sat Apr 15, 2017 2:48 pm

Kevin M wrote:
NancyABQ wrote: But hind-sight is 20/20? I had never heard of tips in 2003... (I had never heard of them until 2016!).
The point is not the hindsight, but using the historical example to help understand why TIPS could be a better investment if purchased today. If you had known about TIPS in 2003, you could have known in advance that would have earned more on a TIPS with a yield of 2.8% than on an I Bond with a yield of 1% if held for 26 years--2.8 times more in real terms.

Now you do know about TIPS. You are saying you plan to hold I Bonds at 0% long term. If by long-term you mean about 30 years, you could recently have bought a 30-year TIPS with a real yield of about 1%. With the I Bond you will have the same purchasing power in 30 years that you have today, while with the TIPS at 1% you'd have about 35% more purchasing power (1.01^30 - 1). This assumes TIPS held in a tax-deferred account, but even in a taxable account you probably would come out better with the TIPS.

Kevin
Okay I think I gotcha -- real rate on 5 year TIPS looks like it is similar to I-Bonds (0-.1%, recently). But for 10-year or 30-year TIPS, the real rate is significantly higher than I-Bonds, so you are saying if I am going to hold them longer than 5 years anyway, then I should be looking at 10 or 30-year TIPS.

(I found this table here: https://www.treasurydirect.gov/instit/a ... result.htm (click on TIPS column))

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Re: ibond vs cd

Post by Kevin M » Sat Apr 15, 2017 4:46 pm

NancyABQ wrote: Okay I think I gotcha -- real rate on 5 year TIPS looks like it is similar to I-Bonds (0-.1%, recently).
As recently as April 10, the yield was about 0.2%, but it dropped a lot in the last few days, and is no longer competitive with I Bonds:

Image
But for 10-year or 30-year TIPS, the real rate is significantly higher than I-Bonds, so you arte saying if I am going to hold them longer than 5 years anyway, then I should be looking at 10 or 30-year TIPS.
Yes. As I said, the main benefit of I Bonds in terms of yield and risk is very low term risk. So if you buy a 5-year TIPs at 0% you're stuck with 0% for five years. With the I Bond, if the real yield on I bonds or short-term TIPS increases significantly above 0% in 1-4 years, you can sell the I Bond, pay the 3-month penalty, and reinvest at the higher yield. Of course you lose the "tax-deferred space" that the I Bond had occupied, so if you would buy your annual allotment anyway, you have to switch to TIPS to get the higher yield.

Same goes for any TIPS. So if 10-year TIPS yield increases from about 0.3%, where it is now, to say 1% in a few years, you're stuck with the 0.3% yield to maturity in the TIPS, but you could sell your 0% I Bonds, pay the small penalty, and reinvest at the higher real yield. You're always taking more term risk with TIPS, but the low term risk of the I Bond does you no good if you hold onto lower-yielding I Bonds when real yields have risen.

The historical cases are used to illustrate that people who have been holding on to their higher-yielding I Bonds would have done even better if they had bought even higher-yielding TIPS instead. Since yields fell instead of increasing, the low term risk of the I Bonds ended up not being utilized.

I just think it's irrational to buy I Bonds at 0% real yield planning to hold them for 10-30 years without even considering cashing them in to buy another inflation-protected security if/when real yields are significantly higher. Some of the other benefits of I Bonds may change the decision point, but some higher real yield will be enough to more than compensate for the other benefits, depending on your particular situation.

You can check real yields daily at Treasury.gov, but for some reason that site isn't working for me now. You can get real yields with maybe a 1-day lag at FRED, as in the graph shown above (which is clickable if you want to edit it, add TIPS of different maturities, change the time period, etc.).

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Re: ibond vs cd

Post by NancyABQ » Sat Apr 15, 2017 6:55 pm

Kevin M wrote: I just think it's irrational to buy I Bonds at 0% real yield planning to hold them for 10-30 years without even considering cashing them in to buy another inflation-protected security if/when real yields are significantly higher. Some of the other benefits of I Bonds may change the decision point, but some higher real yield will be enough to more than compensate for the other benefits, depending on your particular situation.
Kevin
Okay, so your main recommendation is to keep an eye on the real yields of both TIPS and I-bonds, and consider "converting" my low-real-yield I-Bonds in future, rather than blindly holding for 30 years?

That sounds like good advice to me :)

I think the variable part (which will 2.76% for 6 months and then 1.96% for the next 6 months) is good enough to buy them now (before May 1) and hold for at least the required year.

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Re: ibond vs cd

Post by Kevin M » Sat Apr 15, 2017 8:05 pm

NancyABQ wrote:
Okay, so your main recommendation is to keep an eye on the real yields of both TIPS and I-bonds, and consider "converting" my low-real-yield I-Bonds in future, rather than blindly holding for 30 years?
Yes.
NancyABQ wrote: That sounds like good advice to me :)

I think the variable part (which will 2.76% for 6 months and then 1.96% for the next 6 months) is good enough to buy them now (before May 1) and hold for at least the required year.
Yeah, my first I Bond purchase of the batch I currently hold was in May 2011 (I bought some some years before that, but subsequently cashed them in), when the annual inflation component of the rate was 4.6% (and fixed rate was 0%). It seemed like a no-brainer at the time. I continued to by my limit of I Bonds ($20K for me and trust) each year through 2014.

The thing is, when I do an internal rate of return calculation using my purchases and current valuations, my rate of return is only 1.37%. So what was a really good short-term deal at time of the first purchase turned into an inertia thing that ended up not being nearly as attractive. The current higher combined rate will help pull that up some, but over that same period I bought lots of CDs with yields in the 2-3% range, so I've made more from my CDs. The CD deals I've taken advantage of over the last couple of years looked much more attractive to me than I Bonds, so I started passing on I Bonds in 2015.

My I Bonds are a small enough portion of my portfolio that I'm just letting them ride for now, but I can't see holding them long term at 0% and 0.1% real.

When the 5-year TIPS yield was in the 0.5% ballpark in late 2015, I was posting that anyone who planned to hold five years or more should be favoring 5-year TIPS over I Bonds. I should have taken my own advice then and cashed in my I Bonds to buy some 5-year TIPS then, but I've been holding out for 5-year at 1%. :wink: Maybe next time.

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