I don't understand the case for EE bonds

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sometimesinvestor
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I don't understand the case for EE bonds

Postby sometimesinvestor » Thu Apr 20, 2017 5:14 pm

Yes I understand that if I hold for 20 years I can get 3.5% though I am not sure what the return is if I hold it say for 22 years. My main reason for doubt is the unlikelihood of not getting a higher return in the stock market if I am in it for 20 years. I have read there is no 15 year period where one lost money in the stock market so there must be a decent probability of success. In particular if I have averaged over 3.5% over a long period of time I can always choose at that time to lock in my gain (over a ee bond ) by buying a cd.

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Re: I don't understand the case for EE bonds

Postby Theoretical » Thu Apr 20, 2017 5:35 pm

I agree, with the caveat that EEs can make sense for educational uses (tax-free for that use) in a way other bonds cannot. However, 20 year Tennessee Valley Authority zero coupon bonds yield 3.45% (and were yielding a little higher earlier), just 8 basis points less than EE bonds while being liquid throughout.

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Re: I don't understand the case for EE bonds

Postby lack_ey » Thu Apr 20, 2017 5:44 pm

There's been sub-1% real return over 20 years before in the US multiple times, certainly a lot worse than that overseas. Median expectations of inflation are probably under 2.5% for the next 20 years. So it's far from a sure thing that stocks do better than ~3.5% nominal, just a fairly good bet.

But for asset allocation generally the idea most have is not to maximize average or expected returns but to be better positioned across a wider range of outcomes. Maybe not for you.

You know that actual 20-year Treasuries yield about 2.6% now, right? If you don't think EE bonds are good long term, I hope you don't own long-term bonds in general, like the ones in a total bond index fund (though the percentage allocation is modest).

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Re: I don't understand the case for EE bonds

Postby Dominic » Thu Apr 20, 2017 6:49 pm

There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future. It's even more possible for them to return below 3.5% nominally.

EE bonds guarantee that return for 20 years, and are also state-tax free. The coupons are tax-deferred at the federal level (and tax-free for education).

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Re: I don't understand the case for EE bonds

Postby Kevin M » Thu Apr 20, 2017 7:38 pm

I recently bought a 7-year CD at 3%. I'd much rather take this bet than have to hold for 20 years to get 3.5%. If I can earn 4% for the remaining 13 years after the CD matures, I end up making 3.65%. Or maybe a CD will come along in less than 7 years with a rate high enough to justify paying the 1.5% penalty to do an early withdrawal, and I'll earn even more than 3% over 7 years.

The early withdrawal penalty of the EE bond increases with each year until the end of year 20, and approaches the vast majority of your potential earnings as you approach that point. I just don't want to take that much term risk.

EE bonds are a good deal compared to 20-year Treasuries though, with that rate at 2.6%. But then a 7-year CD at 3% also is a great deal, with much less term risk.

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Re: I don't understand the case for EE bonds

Postby jdilla1107 » Thu Apr 20, 2017 7:48 pm

Theoretical wrote:I agree, with the caveat that EEs can make sense for educational uses (tax-free for that use) in a way other bonds cannot. However, 20 year Tennessee Valley Authority zero coupon bonds yield 3.45% (and were yielding a little higher earlier), just 8 basis points less than EE bonds while being liquid throughout.


You are forgetting about the tax deferral which allows one to do tax arbitrage from high income years to low income years. They allow you to expand your tax deferred space.

The 3.53% rate is really like 4.7% for me when comparing to taxable bonds.

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Thu Apr 20, 2017 7:54 pm

Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future. It's even more possible for them to return below 3.5% nominally.

EE bonds guarantee that return for 20 years, and are also state-tax free. The coupons are tax-deferred at the federal level (and tax-free for education).


I'm very much inclined to agree, though your statement that stocks have never lost money over 15 years is incorrect. There was one 20 year period where the real return for the S&P 500 was -.2% annually.

viewtopic.php?t=210755

That being said, the odds are so overwhelmingly in your favor that I see no point in locking up money for twenty years at 3.5%. Besides the fact that the expected returns of stocks are significantly higher, there's just too much distance between here and there. I just heard someone talking about a period in the 1980s when people were afraid to lock in a 30 year bond at 16% because they were afraid of rates going up. We might not see those days again, but then again we might.

Based on history, the best you can realistically hope for with EE bonds is to just barely beat inflation. In the worst case, you'll lose out big time. No thanks.
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Re: I don't understand the case for EE bonds

Postby Kevin M » Thu Apr 20, 2017 7:58 pm

Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

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Re: I don't understand the case for EE bonds

Postby lack_ey » Thu Apr 20, 2017 8:11 pm

Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin

Hm, well EE bonds didn't exist back then, I don't think, and prior EE bonds had different conditions. For a certain range of years they doubled in 17 rather than 20 years IIRC, and a similar hypothetical product offered around that time might not have been as bad as you're suggesting here. In any case we should think about forward inflation and return expectations when analyzing these now.

Point is made with respect to historical returns of stocks, though.

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Re: I don't understand the case for EE bonds

Postby rebellovw » Thu Apr 20, 2017 8:19 pm

Thanks for bringing this up. I'm fairly tempted to buy 20K (my wife and I) this year - I'm 51 - she is 53.

A CD wouldn't workout well as I'm in the 33% tax rate at the moment. Seems like a nice extra 'bucket' of funds to use (in addition to 401K, 403b, tira, r-ira, tax acct) And previously my money was with Fidelity Portfolio Advisory Services (PAS) - they didn't do much better than 3.5%. Thank god I ditched them.

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Re: I don't understand the case for EE bonds

Postby kolea » Thu Apr 20, 2017 8:21 pm

lack_ey wrote:Median expectations of inflation are probably under 2.5% for the next 20 years.


I saw that there has been a down-grading of inflation expectations by those who prognosticate on such things, but I wonder if predicting inflation is any more accurate than predicting interest rates or equity markets.
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Re: I don't understand the case for EE bonds

Postby Kevin M » Thu Apr 20, 2017 8:27 pm

lack_ey wrote:
Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin

Hm, well EE bonds didn't exist back then, I don't think, and prior EE bonds had different conditions. For a certain range of years they doubled in 17 rather than 20 years IIRC, and a similar hypothetical product offered around that time might not have been as bad as you're suggesting here.

Well, bonds got killed over that period. Backtest spreadsheet data indicates cumulative real return for intermediate-term Treasuries of -34%. Short-term Treasuries not so bad at -11%, and cash the best at +0.15%. So you got hurt by the term risk on top of the inflation.

In any case we should think about forward inflation and return expectations when analyzing these now.

Exactly. The point is that term risk hurts worse during high periods of inflation, since you can't roll into higher rates frequently as they ratchet up along with inflation. Real loss of purchasing power for an EE bond with a 0.1% fixed rate for 19 years in a similar environment would be huge.

A way you can get hurt even staying short-term with high inflation is by the government capping nominal rates, as they did in the 1940s. During that inflationary period, cash (Tbills) got killed worse than intermediate-term bonds.

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Re: I don't understand the case for EE bonds

Postby Dominic » Thu Apr 20, 2017 8:48 pm

Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin


My bad. Went off of OP's claim without checking.

I'm not saying I think EE bonds are a great investment, but I think they're an acceptable piece of a fixed income portfolio.

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Re: I don't understand the case for EE bonds

Postby tc101 » Thu Apr 20, 2017 9:12 pm

I have some Series EE issued in 2003. Is now a good time to sell, or should I wait until 2023?
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Re: I don't understand the case for EE bonds

Postby masteraleph » Thu Apr 20, 2017 9:56 pm

tc101 wrote:I have some Series EE issued in 2003. Is now a good time to sell, or should I wait until 2023?


Over the last 14 years, your bond has earned a pretty low amount over the purchase price- somewhere around 2.25% yield or so (and that number has been going down in recent years, because it has a variable rate and the rate is well below that now); it has probably gained about 35% total. Note, incidentally, that the purchase price was half the face value. You might say "my bond is earning relatively little; there are probably better investments I could have been in" (which may not be true, now).

However, your bond will automatically double its original value when it reaches its "original maturity." If it was issued with a date of June 1 or later in 2003, that will occur in 2023, so from now until then, if you hold it, you'll effectively average over 6%/year return (if you hold it through the original maturity date). The deal is even better if the issue date was May 1 or earlier- then you have an original maturity of 17 years, for an effective rate from now until then of 13-14%/year.

Short answer: definitely hold to original maturity. If you want to then, you can consider whether it's worth it to cash in the bond, or to continue holding it until final maturity in 2033.

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Re: I don't understand the case for EE bonds

Postby itstoomuch » Thu Apr 20, 2017 10:52 pm

We market time getting in 1985-87.
We market timed in getting out 2004-06.
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You gotta learn to recognise good values. :greedy
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Re: I don't understand the case for EE bonds

Postby willthrill81 » Thu Apr 20, 2017 10:57 pm

tc101 wrote:I have some Series EE issued in 2003. Is now a good time to sell, or should I wait until 2023?


At this point, hold them to maturity. You've only got to wait six more years to get double the original price, but if you cash them in now, you'll certainly be behind inflation (negative real return).
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Re: I don't understand the case for EE bonds

Postby willthrill81 » Thu Apr 20, 2017 10:59 pm

kolea wrote:
lack_ey wrote:Median expectations of inflation are probably under 2.5% for the next 20 years.


I saw that there has been a down-grading of inflation expectations by those who prognosticate on such things, but I wonder if predicting inflation is any more accurate than predicting interest rates or equity markets.


Considering that the inflation rate for the last 12 months ending last month was 2.4%, I wouldn't bet on median inflation rates below 2.5% for the next 20 years. But I don't bet on interest rates in the first place anyway.
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Re: I don't understand the case for EE bonds

Postby Noobvestor » Fri Apr 21, 2017 12:00 am

3.5% rate - higher than comparable treasuries (currently 2.6%)

Tax-deferred until you cash them out

Option to ditch out in the first few years if rates go up enough (but I started buying in 2012 and it's been a great deal)

Nice way to balance out I Bonds (split 50/50 and it's 50/50 nominal/inflation-protected)

To be they are pretty much a no brainer, at least up until a certain point (wouldn't want them to dominate portfolio)
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Re: I don't understand the case for EE bonds

Postby Noobvestor » Fri Apr 21, 2017 12:03 am

Kevin M wrote:I recently bought a 7-year CD at 3%. I'd much rather take this bet than have to hold for 20 years to get 3.5%. If I can earn 4% for the remaining 13 years after the CD matures, I end up making 3.65%. Or maybe a CD will come along in less than 7 years with a rate high enough to justify paying the 1.5% penalty to do an early withdrawal, and I'll earn even more than 3% over 7 years.


Of course, you end up paying taxes along the way *and* have to pay state taxes, which are pretty high in my state at least (~10%).
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Re: I don't understand the case for EE bonds

Postby lack_ey » Fri Apr 21, 2017 1:15 am

willthrill81 wrote:
kolea wrote:
lack_ey wrote:Median expectations of inflation are probably under 2.5% for the next 20 years.


I saw that there has been a down-grading of inflation expectations by those who prognosticate on such things, but I wonder if predicting inflation is any more accurate than predicting interest rates or equity markets.


Considering that the inflation rate for the last 12 months ending last month was 2.4%, I wouldn't bet on median inflation rates below 2.5% for the next 20 years. But I don't bet on interest rates in the first place anyway.

Wow, you think so, for the long term? You think the Fed is going to shift its target or systemically miss on the upside? What would be the underlying driver for the inflation? Do you think growth is going to get back on the pre-crisis trend?

Given that the 20-year TIPS is at 0.79% real while nominal 20-year Treasury is at 2.61%, that implies the TIPS is a much better deal, where you get paid a significant amount to take the inflation protection (albeit with slightly lower liquidity).

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 2:20 am

lack_ey wrote:
willthrill81 wrote:
kolea wrote:
lack_ey wrote:Median expectations of inflation are probably under 2.5% for the next 20 years.


I saw that there has been a down-grading of inflation expectations by those who prognosticate on such things, but I wonder if predicting inflation is any more accurate than predicting interest rates or equity markets.


Considering that the inflation rate for the last 12 months ending last month was 2.4%, I wouldn't bet on median inflation rates below 2.5% for the next 20 years. But I don't bet on interest rates in the first place anyway.

Wow, you think so, for the long term? You think the Fed is going to shift its target or systemically miss on the upside? What would be the underlying driver for the inflation? Do you think growth is going to get back on the pre-crisis trend?


I don't know, but that's a bet that I see no need to take. For an investment that I have to hold for 20 years, I'm not going to try to barely slide by inflation (what real return are people hoping for here, 1%?) with a potentially big downside (a few years of high inflation and you're hosed). There's very little upside to be had here, but the downside could be huge. Inflation rates of the 1970s and 1980s could happen again.

lack_ey wrote:Given that the 20-year TIPS is at 0.79% real while nominal 20-year Treasury is at 2.61%, that implies the TIPS is a much better deal, where you get paid a significant amount to take the inflation protection (albeit with slightly lower liquidity).


I would definitely purchase TIPS long before EE bonds.
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Re: I don't understand the case for EE bonds

Postby ryman554 » Fri Apr 21, 2017 8:13 am

I agree generally with the sentiment you are sharing.

willthrill81 wrote:That being said, the odds are so overwhelmingly in your favor that I see no point in locking up money for twenty years at 3.5%.


By that logic, however, why did my bank, who presumably has access to many more investment opportunities than the average Joe, give me a mortgage that locks up their money for 3.5% for 30 years some years ago, and will do it for 20 years today?

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 8:36 am

ryman554 wrote:I agree generally with the sentiment you are sharing.

willthrill81 wrote:That being said, the odds are so overwhelmingly in your favor that I see no point in locking up money for twenty years at 3.5%.


By that logic, however, why did my bank, who presumably has access to many more investment opportunities than the average Joe, give me a mortgage that locks up their money for 3.5% for 30 years some years ago, and will do it for 20 years today?


For one, they won't provide you with any deal at any rate unless they strongly believe they can do better. They are not non-profits.

Second, they are borrowing the money they would then loan you at a significantly lower rate than 3.5%. We do not have such an opportunity.

Careful with that logic.
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Re: I don't understand the case for EE bonds

Postby NiceUnparticularMan » Fri Apr 21, 2017 8:42 am

ryman554 wrote:By that logic, however, why did my bank, who presumably has access to many more investment opportunities than the average Joe, give me a mortgage that locks up their money for 3.5% for 30 years some years ago, and will do it for 20 years today?


As an aside, at a given time, commercial banks actually may not have a lot of other great opportunities in terms of loans they could be making. Some may also view mortgages as an opportunity to sell you other products.

But at the end of the day, the main answer to your question is banks are using leverage when making things like mortgage loans to boost their return on investment, which they hope is safe enough in light of the security (the home). And usually that works out well enough for them, but sometimes it blows up spectacularly.

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Re: I don't understand the case for EE bonds

Postby lack_ey » Fri Apr 21, 2017 8:59 am

Forgetting the banks, then why is the bond market so keen on owning the significantly lower returning nominal bonds, under those assumptions? Are the yields being severely depressed on the long end by short-term traders or non-price-sensitive players, with almost everybody who is in a position to care about long-term returns preferring the TIPS?

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 9:11 am

lack_ey wrote:Forgetting the banks, then why is the bond market so keen on owning the significantly lower returning nominal bonds, under those assumptions? Are the yields being severely depressed on the long end by short-term traders or non-price-sensitive players, with almost everybody who is in a position to care about long-term returns preferring the TIPS?


I won't even try to explain why the bond market, or any other market for that matter, does what it does.

From where I'm sitting, all I know is that the 12 months ending last month had inflation of 2.4%, higher than 10 year Treasury yields. Taking that along with the fact that rates are starting to go up and have pretty much nowhere else to go for a while, TIPS seem like a much better approach for fixed income for the foreseeable future.

Going long on a 20 year investment that may barely beat inflation but could fall far behind seems like a very bad bet IMHO.
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Re: I don't understand the case for EE bonds

Postby NiceUnparticularMan » Fri Apr 21, 2017 9:19 am

lack_ey wrote:Forgetting the banks, then why is the bond market so keen on owning the significantly lower returning nominal bonds, under those assumptions?


Yeah, there are a lot of different investors in bonds. Some are just trying to match certain liabilities. Others are making leveraged bets in an attempt to profit. Others are engaged in arbitrage. And so on.

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Re: I don't understand the case for EE bonds

Postby lack_ey » Fri Apr 21, 2017 9:31 am

willthrill81 wrote:
lack_ey wrote:Forgetting the banks, then why is the bond market so keen on owning the significantly lower returning nominal bonds, under those assumptions? Are the yields being severely depressed on the long end by short-term traders or non-price-sensitive players, with almost everybody who is in a position to care about long-term returns preferring the TIPS?


I won't even try to explain why the bond market, or any other market for that matter, does what it does.

From where I'm sitting, all I know is that the 12 months ending last month had inflation of 2.4%, higher than 10 year Treasury yields. Taking that along with the fact that rates are starting to go up and have pretty much nowhere else to go for a while, TIPS seem like a much better approach for fixed income for the foreseeable future.

Going long on a 20 year investment that may barely beat inflation but could fall far behind seems like a very bad bet IMHO.

You're shifting the argument here. I don't particularly like long-term nominal bonds either because of the potential downside, as explained here (also, the long end is typically worse risk/return, with increasingly less extra return for the marginal increase in term risk). As far as I can tell, there seems to be little term premium and you're not really getting any compensation for taking the extra inflation risk.

But earlier you were talking about the average or median, implying that the nominal bonds are priced for significantly lower return than the TIPS. I can't say you're definitively wrong at all, and you're not alone in predicting higher inflation. Also, something more along the lines of 3% would be closer to certain historical averages. But I was just curious in understanding the rationale. I'm always up for coming across a different analysis or understanding.

Generally if you have an opinion that substantially contradicts market expectations, you could be right or wrong, but there needs to be some explaining to be done to say why so many other people are wrong here while trading between two of the more liquid, well known choices available in all the bond market (and that have unambiguously very low and similar credit risk).

NiceUnparticularMan wrote:
lack_ey wrote:Forgetting the banks, then why is the bond market so keen on owning the significantly lower returning nominal bonds, under those assumptions?


Yeah, there are a lot of different investors in bonds. Some are just trying to match certain liabilities. Others are making leveraged bets in an attempt to profit. Others are engaged in arbitrage. And so on.

Then why is there currently not enough interest from long-term holders, value seekers (not academic arbitrage but riding the better trade), etc. to bring breakeven inflation at least moderately in line with actual inflation expectations? Do you think nominal/real yield differentials are generally bunk or just might be currently off?

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Re: I don't understand the case for EE bonds

Postby aristotelian » Fri Apr 21, 2017 9:33 am

Obviously the case for EE bonds right now is difficult, when they earn a fixed rate of 0.1%. That gives you a huge withdrawal penalty and makes them essentially illiquid for 20 years. However, right now interest rates are at historical lows. The Fed is engaged in a massive economic engineering experiment that is making stocks look better and discouraging traditional saving instruments. When interest rates normalize, the withdrawal hit will not be as severe and EE bonds will be a better option.

I would still consider them if I did not have a 401K and needed to increase my bond allocation.

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Re: I don't understand the case for EE bonds

Postby sometimesinvestor » Fri Apr 21, 2017 9:42 am

Dominic wrote:
Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin


My bad. Went off of OP's claim without checking.

I'm not saying I think EE bonds are a great investment, but I think they're an acceptable piece of a fixed income portfolio.




While I won't disagree with the info provided though I have not checked it but as the OP I defend myself by noting that I did not use the term REAL Return and believe my statement is correct for nominal dollars

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 9:52 am

lack_ey wrote:But earlier you were talking about the average or median, implying that the nominal bonds are priced for significantly lower return than the TIPS. I can't say you're definitively wrong at all, and you're not alone in predicting higher inflation. Also, something more along the lines of 3% would be closer to certain historical averages. But I was just curious in understanding the rationale. I'm always up for coming across a different analysis or understanding.


Again, I'm not going to try to explain why the market is doing what it's doing. But I think it's very likely that many investors are continuing to snatch up these sub-inflation yield bonds simply because their AA calls for it. It seems very likely to be a losing proposition, at least in the short term.

Back to EE bonds, locking in a 3.5% rate for twenty years just seems ludicrous to me when you consider the not distant past. As I already said, there were people in the 1980s who were afraid to lock in a 16% rate on a 30 year loan for fear of interest rates rising even more. But now people view locking in a 3.5% (at most 1.5% real) as a safe investment? In light of history, that seems like a far riskier bet than just going long on stocks, for instance, for twenty years.
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Re: I don't understand the case for EE bonds

Postby ACM4297 » Fri Apr 21, 2017 10:03 am

sometimesinvestor wrote:
Dominic wrote:
Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin


My bad. Went off of OP's claim without checking.

I'm not saying I think EE bonds are a great investment, but I think they're an acceptable piece of a fixed income portfolio.




While I won't disagree with the info provided though I have not checked it but as the OP I defend myself by noting that I did not use the term REAL Return and believe my statement is correct for nominal dollars


Yup, and comparing 3.53% nominal yield to -5% real yield is apples and oranges. I don't believe there is a case for EE Bonds except a psychological one, possibly as tax deferment, and to fund education. In years 1-19 you would always be better off with an I Bond (assuming inflation above 0.134%) or CDs. I Bonds guarantee generally keeping pace with inflation and CDs guarantee a greater 0.10% nominal return. At 20 years you hit 3.53%, but there are many many investments that have returned at least that over 20 years. Using Portfolio Charts, we see that an 80/20 portfolio has always returned greater than 4% real CAGR (~6% nominal) over each 20 year period we have data for. Even a 25/75 portfolio has at least 3% real CAGR over every 20 year time period which is 5.06% nominal using 2% inflation. After year 20, the argument only gets worse for EE Bonds.

Do not use EE Bonds unless: you're ready to lock away money for 20 years, you need the peace of mind, you want the tax deferment, you're paying for education. Even if these conditions are met, bonds/munis/balanced portfolios, CDs in some points of time, I Bonds, and many other investments should be considered as well.

TL;DR: EE Bonds are good in narrow circumstances, but are generally not the best investment. Their best argument comes from generating more tax-deferred space.

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Re: I don't understand the case for EE bonds

Postby Kevin M » Fri Apr 21, 2017 11:52 am

Noobvestor wrote:
Kevin M wrote:I recently bought a 7-year CD at 3%. I'd much rather take this bet than have to hold for 20 years to get 3.5%. If I can earn 4% for the remaining 13 years after the CD matures, I end up making 3.65%. Or maybe a CD will come along in less than 7 years with a rate high enough to justify paying the 1.5% penalty to do an early withdrawal, and I'll earn even more than 3% over 7 years.

Of course, you end up paying taxes along the way *and* have to pay state taxes, which are pretty high in my state at least (~10%).

My marginal tax rate will be higher in 20 years than it is now, so the tax deferral has no value to me, and the state taxes aren't enough to justify the huge term risk with an EE bond. However, tax-deferral and state-tax exemption are considerations to factor in.

Also, you can hold the CD in a tax-advantaged account, which is essentially a tax-free account if you properly adjust your allocation for taxes, and then hold stocks in taxable. I hold this particular CD in a tax-advantaged account, but I do hold other CDs in taxable, since my fixed income allocation is too large to fit in tax-advantaged.

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Re: I don't understand the case for EE bonds

Postby Dominic » Fri Apr 21, 2017 11:55 am

sometimesinvestor wrote:
Dominic wrote:
Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.

Kevin


My bad. Went off of OP's claim without checking.

I'm not saying I think EE bonds are a great investment, but I think they're an acceptable piece of a fixed income portfolio.




While I won't disagree with the info provided though I have not checked it but as the OP I defend myself by noting that I did not use the term REAL Return and believe my statement is correct for nominal dollars


Didn't mean it to throw you under the bus. And comparing nominal returns make sense considering we're discussing EE bonds with a fixed nominal return anyway.

You are correct about nominal returns. The longest stock market drawdown lasted 13 years, per Portfolio Charts.

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Re: I don't understand the case for EE bonds

Postby Angst » Fri Apr 21, 2017 12:07 pm

Kevin M wrote:My marginal tax rate will be higher in 20 years than it is now, so the tax deferral has no value to me, and the state taxes aren't enough to justify the huge term risk with an EE bond. However, tax-deferral and state-tax exemption are considerations to factor in.

How can you know this? It's not unreasonable for some people to be able to have a fairly clear expectation of what their taxable income might be 20 years out, but tax rates?

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Re: I don't understand the case for EE bonds

Postby knpstr » Fri Apr 21, 2017 12:13 pm

Warren Buffett calls long-term bonds one of the worst investments.

Buffett said that while the safety of investments in things like bonds are often lauded -- U.S. Treasury bonds had a yield of 5.7% since he took the helm at Berkshire 47 years ago -- he suggested that in reality "they are among the most dangerous of assets."

The principal concern is inflation, the reality that with almost every passing day, little by little a dollar loses its value.In the letter Buffett said in the same 47 years, the value of a dollar had fallen by a stunning 86%, meaning that "it takes no less than $7 today to buy what $1 did at that time."

A bond -- or an investment like it -- would need to return 4.3% just to maintain its purchasing power over that time. And while government bonds averaged a 5.7% yield, it's critical to remember that was ­pre-tax. As a result, an investor who fell in the 25% tax bracket would've lost the remaining 1.4% in tax payments.


Buffett does suggest using short term treasuries as a place to park money for liquidity.
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Re: I don't understand the case for EE bonds

Postby hollowcave2 » Fri Apr 21, 2017 12:21 pm

Yes, the expected return in the stock market is better than EE bonds, which it should be, because its a different asset class that entails more risk. If you take more risk, you should have a higher expectation of return.

EE bonds are supposed to be ultra safe and guaranteed by the U.S. government. They serve a certain purpose in a portfolio, such as safety and asset allocation balance. Of course you can get better returns elsewhere.... with a correspondingly higher risk.

Having said all of that, I am near retirement and not interested in holding these for 20 years. If I were younger, however, I might consider them as a small portion of my bond portfolio.

Seems like all savings bonds these days are not at all attractive as they used to be. Between the low rate on EE's and the zero fixed rate on the I-bonds, I have not made any purchase for awhile. I do see the benefit of I-bonds if the variable rate is known for the next year. Those are probably the best bet in savings bonds these days.

Just my 2 cents.

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Re: I don't understand the case for EE bonds

Postby Earl Lemongrab » Fri Apr 21, 2017 12:59 pm

jdilla1107 wrote:You are forgetting about the tax deferral which allows one to do tax arbitrage from high income years to low income years.

That will work for some people but current EE bonds only make sense if held exactly 20 years. For a lot of younger people that means cashing them at their peak earnings.
They allow you to expand your tax deferred space.

Only in a fashion similar to non-deductible IRA contributions. The principal is after-tax, so only the earnings are deferred, and that's pretty small in this context.
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Re: I don't understand the case for EE bonds

Postby Kevin M » Fri Apr 21, 2017 1:02 pm

sometimesinvestor wrote:
Dominic wrote:
Kevin M wrote:
Dominic wrote:There has yet to be a 15-year period where stocks have lost money, but it's not impossible for it to happen in the future.

Based on data in our Simba backtest spreadsheet, US stocks had a cumulative real return of -5% over the 17-year period 1965-1981 (inclusive). Of course that high-inflation period would have killed EE bonds in real terms.


While I won't disagree with the info provided though I have not checked it but as the OP I defend myself by noting that I did not use the term REAL Return and believe my statement is correct for nominal dollars

Yes, our backtest data supports this. Longest losing period for US stocks in nominal dollars was the 14-year period 1929-1942 (inclusive), with a cumulative nominal return of -13.5% (-1% annualized).

Worst 15-year period for US stocks in nominal terms was 1929-1943, with a cumulative nominal return of +8.5% (annualized 0.5%). However, during this same period, the cumulative nominal return for intermediate-term Treasuries was +78% (3.9% annualized). So even though stocks had a positive nominal return, bonds had a much better return.

However, if we extend the time period to 20 years, to match the time for an EE bond to double, there is only one period since 1926 when stocks had an annualized nominal return of less than 3.5% (3.0% starting in 1929), with the next worst annualized nominal return at 4.3% (starting in 1930). So, if you believe that historical results for US stocks are a good guide to future probability distributions, then the odds are way in your favor with stocks over EE bonds.

In the OP, you wrote:
sometimesinvestor wrote:I have read there is no 15 year period where one lost money in the stock market <snip>

So it depends how you define "lost money". I think the common understanding is the way you seemed to mean it--lost value in nominal dollars. I just think it's important to continue to stress that it's usually more rational to think in real terms, since it's purchasing power that we usually care about.

Keep in mind that although I was correcting your statement about stocks (in real terms), I also noted that during the period when stocks did worst in real terms, bond returns were even worse in real terms, and EE bonds (as they exist today) would also have done worse. So this wasn't an argument against your overall point in the OP.

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Re: I don't understand the case for EE bonds

Postby sreynard » Fri Apr 21, 2017 1:06 pm

I always looked at EE bonds as a saving vehicle not as in investment. Young people could allocate a percentage of their pay to EE bonds and a few years later cash them in to buy a car, the down payment on a house, or to help pay for college. There were probably times when they turned out to be reasonably good investments, but I see no way you would know this twenty (or seventeen) years in advance.

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Re: I don't understand the case for EE bonds

Postby Grt2bOutdoors » Fri Apr 21, 2017 1:11 pm

willthrill81 wrote:
I would definitely purchase TIPS long before EE bonds.


I see no upside to holding TIPS in a taxable account. There is nothing worse than paying tax on phantom income for the inflation adjustment, the only way you realize the income is to completely liquidate the TIPS holding which sort of defeats the purpose doesn't it? The EE while not inflation adjusted is a tax deferral mechanism and as previously pointed out earlier in the thread, if you anticipate moving from a high income tax bracket to a lower one in retirement, your tax liability on the EE interest may be much lower or quite possibly zero in retirement depending on how your other investments/income stream is structured. I like to think of the EE for those who can hold to maturity as a term certain pension or fixed annuity - you know the rate, you know the term and you know the amount you will get with AAA certainty. You can't get much better than US Treasury when it comes to ratings, leaving aside the S&P mistake of a couple of years ago.
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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 1:14 pm

hollowcave2 wrote:Yes, the expected return in the stock market is better than EE bonds, which it should be, because its a different asset class that entails more risk. If you take more risk, you should have a higher expectation of return.

EE bonds are supposed to be ultra safe and guaranteed by the U.S. government. They serve a certain purpose in a portfolio, such as safety and asset allocation balance. Of course you can get better returns elsewhere.... with a correspondingly higher risk.


These EE bonds have a major risk to them: inflation. If the next twenty years bring historical rates of inflation, then the real return of EE bonds will be close to zero. But if inflation is higher than that, you then lose with EE bonds, possibly in a big way.

For instance, from January, 1970, to January, 1990, the dollar lost 70.5% of its value. This means that $1 in 1970 had the same buying power as $3.40 in 1990. If you only doubled your nominal investment over that period, then your real cumulative return was -41.1%.
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I'm not saying that that is likely to happen again, but the point is that these are certainly not risk-free investments as some tout them to be.

As Kevin M has pointed out, there's been a grand total of one 20 year period where stocks had a nominal return under 3.5%. A lump sum invested in equities over twenty years is, in my view, far less risky than EE bonds, with a far larger upside to boot.
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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 1:19 pm

Grt2bOutdoors wrote:
willthrill81 wrote:
I would definitely purchase TIPS long before EE bonds.


I see no upside to holding TIPS in a taxable account.


Even with the tax implications, I would rather have TIPS than EE bonds in a taxable account due to the inflation risk. If my tax bracket was high, I would consider holding muni bonds in lieu of TIPS.

That being said, White Coat Investor makes a compelling argument that all bonds should be in a taxable account.

http://whitecoatinvestor.com/asset-loca ... n-taxable/

I reiterate that locking away money for 20 years at a rate that is historically likely to barely keep pace with inflation has virtually no upside.
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Re: I don't understand the case for EE bonds

Postby Grt2bOutdoors » Fri Apr 21, 2017 1:20 pm

sreynard wrote:I always looked at EE bonds as a saving vehicle not as in investment. Young people could allocate a percentage of their pay to EE bonds and a few years later cash them in to buy a car, the down payment on a house, or to help pay for college. There were probably times when they turned out to be reasonably good investments, but I see no way you would know this twenty (or seventeen) years in advance.


The reason you know it to be a decent investment on an apples to apples basis is as follows:

US Treasury 20 year issue is currently yielding 2.61%. The interest is paid semi-annually, but is also fully taxable at Federal levels. Rating: AAA

EE Savings bond - 20 year guarantee to double in face value irrespective of current coupon which is currently 0.10%. 100% tax deferred at purchaser's option (you can declare your interest income accrued each year, but at your option not that of issuer). At 20 year anniversary of purchase, face value doubles, that is currently a 3.53% annualized return, but you need to hold it for exactly 20 years. Rating: AAA

On annualized rate - winner EE bond
On tax deferral - winner EE bond
On current coupon - winner US Treasury Note
On principal protection - winner EE bond. You can sell your US Treasury Note at any time, the price you get however is a different story; its based on market whims.

Ultimately, the purchaser who presumably wrote their own Investment Policy Statement should weigh the pros and cons of their own situation before reaching a decision to buy or sell. I hold EE bonds as part of a diversified equity/fixed income portfolio that is the basis of my retirement savings. Each holding has their own role to play.
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Re: I don't understand the case for EE bonds

Postby Kevin M » Fri Apr 21, 2017 1:21 pm

sreynard wrote:I always looked at EE bonds as a saving vehicle not as in investment. Young people could allocate a percentage of their pay to EE bonds and a few years later cash them in to buy a car, the down payment on a house, or to help pay for college.

This makes no sense with EE bonds being issued currently. You earn 0.1% if you redeem before 20 years, so it makes no sense to buy an EE bond for anything less than a 20-year time period. You can earn 1% in a savings account, so 10X more, and no amount of tax-deferral or state-income tax exemption is going to compensate for that difference.

There were probably times when they turned out to be reasonably good investments, but I see no way you would know this twenty (or seventeen) years in advance.

We know in advance that an EE bond bought today is a bad investment for a 17-year period. You will earn 0.1% annualized, while you can earn about 2.5% on a 17-year Treasury (with 10-year yield at 2.24% and 20-year at 2.61%).

We know in advance that you'll earn 3.53% annualized for a 20-year period. What we don't know is whether or not this will end up being good relative to the alternatives. We know in advance it will be better than buying a 20-year Treasury at a yield of 2.6% and holding to maturity.

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Re: I don't understand the case for EE bonds

Postby Grt2bOutdoors » Fri Apr 21, 2017 1:22 pm

willthrill81 wrote:
Grt2bOutdoors wrote:
willthrill81 wrote:
I would definitely purchase TIPS long before EE bonds.


I see no upside to holding TIPS in a taxable account.


Even with the tax implications, I would rather have TIPS than EE bonds in a taxable account due to the inflation risk. If my tax bracket was high, I would consider holding muni bonds in lieu of TIPS.

That being said, White Coat Investor makes a compelling argument that all bonds should be in a taxable account.

http://whitecoatinvestor.com/asset-loca ... n-taxable/

I reiterate that locking away money for 20 years at a rate that is historically likely to barely keep pace with inflation has virtually no upside.


I use equities for risk, the purpose of fixed income is to protect the savings face value I can not afford to lose, ever. TIPS can expose you to deflationary losses, nominal bonds have a place in a portfolio.
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Re: I don't understand the case for EE bonds

Postby flamesabers » Fri Apr 21, 2017 1:27 pm

OP,

I think perhaps the best case for EE Bonds is as a gift from relatives to young children. Unlike CDs, EE Bonds have the minimum purchase amount of only $25 for a rate of about 3.5%. Also, because the holding period of EE Bonds is twenty years, that eliminates the hassle for the parents having to keep track of the money while the kid is still a minor. Parents don't have to keep track of 1099s every year nor do parents have to keep up with Bank X being bought out by Bank Y or Bank X sending out notices that the CD is renewing at such and such rate. By the time the EE Bond reaches maturity, the kid is now a young adult (most likely in a low tax bracket/going to college) when the amount of tax liability on the interest will be minimal if not zero.

If paper EE bonds were still being issued I would probably buy them for my niece and nephew every now and then.

sreynard wrote:I always looked at EE bonds as a saving vehicle not as in investment. Young people could allocate a percentage of their pay to EE bonds and a few years later cash them in to buy a car, the down payment on a house, or to help pay for college. There were probably times when they turned out to be reasonably good investments, but I see no way you would know this twenty (or seventeen) years in advance.


I find I-Bonds to be more suited for savings then EE Bonds. I-Bonds can be redeemed without penalty after five years vs. twenty years for EE Bonds.

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Re: I don't understand the case for EE bonds

Postby willthrill81 » Fri Apr 21, 2017 1:31 pm

Grt2bOutdoors wrote:I use equities for risk, the purpose of fixed income is to protect the savings face value I can not afford to lose, ever. TIPS can expose you to deflationary losses, nominal bonds have a place in a portfolio.


So you view a twenty year holding for equities as being more risky than holding a 3.5% nominal bond for the same period? I can point to many more historical periods where you would have lost more buying power with the bonds than with the stocks over twenty years.
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Re: I don't understand the case for EE bonds

Postby Grt2bOutdoors » Fri Apr 21, 2017 1:39 pm

willthrill81 wrote:
Grt2bOutdoors wrote:I use equities for risk, the purpose of fixed income is to protect the savings face value I can not afford to lose, ever. TIPS can expose you to deflationary losses, nominal bonds have a place in a portfolio.


So you view a twenty year holding for equities as being more risky than holding a 3.5% nominal bond for the same period? I can point to many more historical periods where you would have lost more buying power with the bonds than with the stocks over twenty years.


For retirement money, I have a serious issue with holding a 100% or even 80% equity portfolio. I'm gliding down as I reach either age or asset targets. I only take risk when willing, able or needing to. The last thing I want to experience is a bad sequence of returns when I'm 5 years away from retiring. It could take longer than that to recover.
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