I don't understand the case for EE bonds

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sat Apr 22, 2017 11:48 am

Nate79 wrote:All of that may be true but that is not what liquid/illiquid means. Posters saying that EE bonds are illiquid either don't understand how they work or need to explain themselves more and not use incorrect term. At today's low fixed rate they are basically cash.
According to Investopedia:
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.
http://www.investopedia.com/terms/l/liquidity.asp

It's a little hard to apply this concept to EE bonds because they are not generally marketable. But ordinarily if you were looking at an asset that, say, was going to be worth double its face value in 10 years, to sell it at face value would be to dramatically underprice it.

So, I honestly think it does not make sense to call an asset subject to those rules "liquid." A fair accounting of its value should include its pending doubling, and so if you redeem early and lose that doubling, you have negatively affected its price.

FactualFran
Posts: 460
Joined: Sat Feb 21, 2015 2:29 pm

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

Post by FactualFran » Sat Apr 22, 2017 12:36 pm

itstoomuch wrote: But in 1985, Bogle was barely known and Reagan had the backing of the people. Our 6% bonds was competitive to CDs although we didn't get a toaster. And it was the toaster that eventually killed the S&Ls in the late 1980s.

Today the bond market is easily understood and bought/sold. Savings Bonds are now difficult to understand and buy/sell. Perhaps the Gov doesn't want you to know??? I no longer pay attention.
For me current EE bonds are easier to understand than the ones issued in 1985.

With the current ones, the redemption value increases at a fixed rate except that the redemption value is guaranteed to be twice the purchase price after a certain number of years.

With the ones issued 1985, the redemption value increased in complex ways. The redemption value was the higher of the values calculated using a 1) guaranteed yield or 2) market based yield that depends on the yield of Treasury Notes over time. The guaranteed minimum yield was different at different times: over the first 5 years it started at 4% and increased to 7.5%, it continued at 7.5% for 10 the next 5 years, and it then decreased to 4%.
Last edited by FactualFran on Sat Apr 22, 2017 5:44 pm, edited 2 times in total.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 1:43 pm

FactualFran wrote:With the ones issued 1985, the redemption value increased in complex ways. The redemption value was the higher of the values calculated using a 1) guaranteed yield or 2) market based yield that depends on the yield of Treasury Notes over time. The guaranteed yield was different at different times: over the first 5 years it started at 4% and increased to 7.5%, it continued at 7.5% for 10 years, and it then decreased to 4%.
If there was a significant possibility of upside potential with current EE bonds (7.5% would have me dancing right now :D), the entire equation would change. But a guaranteed .1% or 3.5% if you leave it tied up for twenty years just doesn't do it for me. I can't help but believe strongly that there are many other ways to earn (1) a better return with (2) more liquidity. The guarantee is what really gets some people, and I do understand that, but like most guarantees, it doesn't guarantee you much.

I would assume that people who are attracted to EE bonds might also be attracted to annuities with guaranteed minimum returns, though those depend on the insurance company and not the U.S. government.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

itstoomuch
Posts: 4835
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

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

Post by itstoomuch » Sat Apr 22, 2017 1:56 pm

^ only if it makes sense.
No bonds in our current mix. Holding extraordinary amount of cash.
YMMV
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sat Apr 22, 2017 3:23 pm

willthrill81 wrote:
NiceUnparticularMan wrote:So that's an odd argument to me. Maybe if you got lucky with your bad luck, so to speak, the deflationary scenario happens right before they double. Otherwise, it seems to me you are running a serious risk of not being able to get the benefit of holding nominal long bonds in a deflationary scenario when you actually need it.
I concur.

A long-term illiquid bond at a low yield, even if it's higher than other bond yields, just seems like a bad deal all the way around.
I own a few long term bonds but mostly short and intermediate. I believe my diversified portfolio protects me in the event of inflation, disinflation, or outright deflation. EE bonds are part of that portfolio.

You keep calling the yields "low". They are not low, unless you know what rates will be 10 and 20 years from now.

Yes, I am also attracted to annuities, though not at my age. In retirement, I will shop them.

You keep comparing EE bonds to stocks and saying the stocks have better returns. Or sometimes you say they have better returns and more liquidity. You are missing the points. EE bonds have a guaranteed 20 year return, which stocks do not offer. I grant you, it is likely that stocks will outperform EE bonds over the next 20 years. That's why I own stocks. But it is not guaranteed. That's why I own EE bonds. And we may have inflation. That's why I own I bonds. And the dollar may fall. That's why I own International stocks. Or the dollar may rise. That's why I own US stocks. etc, etc. This is what MPT means. It's not about the performance of a single asset class. It's about the role of an asset class in a diversified portfolio to increase risk-adjusted return, ie, efficiency.
Last edited by letsgobobby on Sat Apr 22, 2017 4:01 pm, edited 1 time in total.

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sat Apr 22, 2017 3:36 pm

If one thought there was a substantial chance EE bonds could outperform stocks over 20 years (not a majority chance, necessarily, but substantial), I could see why one might hold them.

For risk-management purposes, however, they do seem to have a rather unfortunate structure.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 3:49 pm

letsgobobby wrote:
willthrill81 wrote:
NiceUnparticularMan wrote:So that's an odd argument to me. Maybe if you got lucky with your bad luck, so to speak, the deflationary scenario happens right before they double. Otherwise, it seems to me you are running a serious risk of not being able to get the benefit of holding nominal long bonds in a deflationary scenario when you actually need it.
I concur.

A long-term illiquid bond at a low yield, even if it's higher than other bond yields, just seems like a bad deal all the way around.
I own a few long term bonds but mostly short and intermediate. I believe my diversified portfolio protects me in the event of inflation, disinflation, or outright deflation. EE bonds are part of that portfolio.

You keep calling the yields "low". They are not low, unless you know what rates will be 10 and 20 years from now.
I call them low because the rate of return after twenty years is only 1.1% higher than our current inflation rate (2.4% for the 12 months ending in March, 2017). And if the inflation rate rises to meet the historical average, the real return of EE bonds will drop to about .25%. I don't know anyone who wouldn't call that low, regardless as to what future rates will be. And yes, deflation would change this equation, but aside from that being a very unlikely (historically speaking) long-term event, EE bonds would not far much better than cash, CDs, treasuries, or any other type of long-term bond. And your returns are far more liquid with virtually any other alternative.

So in a best case scenario for EE bonds, they come out slightly ahead of the far more common alternatives. In a worst case scenario, high inflation absolutely destroys them. That seems like close to a one-sided bet to me, but it doesn't to you for the reasons you outline below.
letsgobobby wrote:You keep comparing EE bonds to stocks and saying the stocks have better returns. Or sometimes you say they have better returns and more liquidity. You are missing the points. EE bonds have a guaranteed 20 year return, which stocks do not offer. I grant you, it is likely that stocks will outperform EE bonds over the next 20 years. That's why I own stocks. But it is not guaranteed. That's why I own EE bonds. And we may have inflation. That's why I own I bonds. And the dollar may fall. That's why I own US stocks. Or the dollar may rise. That's why I own US stocks. etc, etc. This is what MPT means. It's not about the performance of a single asset class. It's about the role of an asset class in a diversified portfolio to increase risk-adjusted return, ie, efficiency.
I totally get diversification, which is a very worthwhile goal. However, that does not mean that every investment that potentially could be slihgtly beneficial in some obscure, unlikely situation reasonable though, IMHO.

Even if I knew for 100% sure that deflation was going to happen over the next twenty years, I wouldn't be buying EE bonds.

But you believe they have a place in your portfolio, and that's fine. You place a lot of importance on long-term government guarantees, and I do not.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sat Apr 22, 2017 4:01 pm

willthrill81 wrote:
letsgobobby wrote:
willthrill81 wrote:
NiceUnparticularMan wrote:So that's an odd argument to me. Maybe if you got lucky with your bad luck, so to speak, the deflationary scenario happens right before they double. Otherwise, it seems to me you are running a serious risk of not being able to get the benefit of holding nominal long bonds in a deflationary scenario when you actually need it.
I concur.

A long-term illiquid bond at a low yield, even if it's higher than other bond yields, just seems like a bad deal all the way around.
I own a few long term bonds but mostly short and intermediate. I believe my diversified portfolio protects me in the event of inflation, disinflation, or outright deflation. EE bonds are part of that portfolio.

You keep calling the yields "low". They are not low, unless you know what rates will be 10 and 20 years from now.
I call them low because the rate of return after twenty years is only 1.1% higher than our current inflation rate (2.4% for the 12 months ending in March, 2017). And if the inflation rate rises to meet the historical average, the real return of EE bonds will drop to about .25%. I don't know anyone who wouldn't call that low, regardless as to what future rates will be. And yes, deflation would change this equation, but aside from that being a very unlikely (historically speaking) long-term event, EE bonds would not far much better than cash, CDs, treasuries, or any other type of long-term bond. And your returns are far more liquid with virtually any other alternative.

So in a best case scenario for EE bonds, they come out slightly ahead of the far more common alternatives. In a worst case scenario, high inflation absolutely destroys them. That seems like close to a one-sided bet to me, but it doesn't to you for the reasons you outline below.
letsgobobby wrote:You keep comparing EE bonds to stocks and saying the stocks have better returns. Or sometimes you say they have better returns and more liquidity. You are missing the points. EE bonds have a guaranteed 20 year return, which stocks do not offer. I grant you, it is likely that stocks will outperform EE bonds over the next 20 years. That's why I own stocks. But it is not guaranteed. That's why I own EE bonds. And we may have inflation. That's why I own I bonds. And the dollar may fall. That's why I own US stocks. Or the dollar may rise. That's why I own US stocks. etc, etc. This is what MPT means. It's not about the performance of a single asset class. It's about the role of an asset class in a diversified portfolio to increase risk-adjusted return, ie, efficiency.
I totally get diversification, which is a very worthwhile goal. However, that does not mean that every investment that potentially could be slihgtly beneficial in some obscure, unlikely situation reasonable though, IMHO.

Even if I knew for 100% sure that deflation was going to happen over the next twenty years, I wouldn't be buying EE bonds.

But you believe they have a place in your portfolio, and that's fine. You place a lot of importance on long-term government guarantees, and I do not.
what if you expected inflation to be 1% over the next 20 years?

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sat Apr 22, 2017 4:08 pm

Nate79 wrote: All of that may be true but that is not what liquid/illiquid means. Posters saying that EE bonds are illiquid either don't understand how they work or need to explain themselves more and not use incorrect term.
To many of us, liquidity means that you can sell quickly and easily without losing money. With EE bonds, you can sell quickly and easily after one year, but you're going to lose a bunch of money compared to holding for 20 years, and the longer you hold (up until 20 years), the more you lose.

If you redeem after 19 years, you'll get $10,191 for your $10K face value EE bond, while if you hold for one more year, you'll get $20,000. That's not liquidity in the sense being used here. In the sense being used here, the longer you hold them (up until 20 years), the less liquid they are.

Liquidity/illiquidity in this sense is often used here to explain the big drop in TIPS prices in late 2008. It's not that you couldn't sell them at all, it's that you couldn't sell them without taking a big haircut relative to what you would have received if you didn't have to sell between mid-Oct and mid-Nov.
At today's low fixed rate they are basically cash.
For retail investors, cash is a savings account earning about 1%, or maybe a money market fund earning 0.85%. Even for institutional investors, cash is a 1-month Tbill earning 0.75%. I would try to hold as little cash as possible at 0.1% (e.g., my Ally checking account with less than $15K in it--even Ally checking pays 0.6% with $15K or more in checking).

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 4:10 pm

letsgobobby wrote:what if you expected inflation to be 1% over the next 20 years?
A guaranteed 2.5% real return (assuming you knew precisely what inflation would be) would sound good except that I can't change my mind mid-stream without losing essentially all of the return.

So even if I knew with 100% certainty that inflation would be 1% for twenty years (and of course no one knows that), I'd still rather have another type of bond with liquid returns. The reason is because you don't know what everything else will do in that period of time. We could very well be looking at 6% treasuries again in ten years or less. Locking in an investment for two decades for at most a ~1% benefit over the alternatives does not qualify as a good risk-adjusted return to me.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

birdy
Posts: 277
Joined: Sun May 02, 2010 7:31 pm

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

Post by birdy » Sat Apr 22, 2017 4:38 pm

I purchased my EE Bonds in 1992. I have always intended to hold to maturity and nothing has changed. As a part of a diversified portfolio they still are a good fit for me. I have not purchased any more since then, as I started to do CD ladders and VG bond funds. My spouse and I are now retired (age 62) and now are past the accumulation faze of our life. I of course want my portfolio to continue to grow but am not looking to make any major changes to our 60/40 investments. A 17-20 year investment is now not practical at our age.

birdy

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sat Apr 22, 2017 4:45 pm

willthrill81 wrote:
letsgobobby wrote:what if you expected inflation to be 1% over the next 20 years?
A guaranteed 2.5% real return (assuming you knew precisely what inflation would be) would sound good except that I can't change my mind mid-stream without losing essentially all of the return.

So even if I knew with 100% certainty that inflation would be 1% for twenty years (and of course no one knows that), I'd still rather have another type of bond with liquid returns. The reason is because you don't know what everything else will do in that period of time. We could very well be looking at 6% treasuries again in ten years or less. Locking in an investment for two decades for at most a ~1% benefit over the alternatives does not qualify as a good risk-adjusted return to me.
The chances of 6% treasuries and 1% inflation coexisting for any length of times are slim and none.

Just as you say I place a stronger value on 'guaranteed' than you, you place a stronger value on 'liquid' than I do. For this sall portion of my portfolio, I have no need for liquidity. According to Larry Swedroe, I should therefore attempt to earn a liquidity premium because why pay for something I don't need?

I also own some entirely illiquid muni bonds paying 4.5% over 10 years (AA rated). Again - liquidity is meaningless to me for the portions of my portfolio involved. I can earn a premium by willingly surrendering liquidity.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 4:50 pm

letsgobobby wrote:
willthrill81 wrote:
letsgobobby wrote:what if you expected inflation to be 1% over the next 20 years?
A guaranteed 2.5% real return (assuming you knew precisely what inflation would be) would sound good except that I can't change my mind mid-stream without losing essentially all of the return.

So even if I knew with 100% certainty that inflation would be 1% for twenty years (and of course no one knows that), I'd still rather have another type of bond with liquid returns. The reason is because you don't know what everything else will do in that period of time. We could very well be looking at 6% treasuries again in ten years or less. Locking in an investment for two decades for at most a ~1% benefit over the alternatives does not qualify as a good risk-adjusted return to me.
The chances of 6% treasuries and 1% inflation coexisting for any length of times are slim and none.
I never said that they would coexist. I said that the likelihood of one event (6% treasuries) is at least as strong as the likelihood of another (1% inflation).
letsgobobby wrote:Just as you say I place a stronger value on 'guaranteed' than you, you place a stronger value on 'liquid' than I do. For this sall portion of my portfolio, I have no need for liquidity. According to Larry Swedroe, I should therefore attempt to earn a liquidity premium because why pay for something I don't need?

I also own some entirely illiquid muni bonds paying 4.5% over 10 years (AA rated). Again - liquidity is meaningless to me for the portions of my portfolio involved. I can earn a premium by willingly surrendering liquidity.
You are willing to sacrifice liquidity and accept long-term inflation risk for a tiny gain and a government guarantee. That's the bottom line. You clearly like it, so that's fine.

And while you didn't specifically say this, I very much doubt that Larry Swedroe would ever recommend EE bonds in the current environment. He widely advocates CDs and ITT.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

FactualFran
Posts: 460
Joined: Sat Feb 21, 2015 2:29 pm

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

Post by FactualFran » Sat Apr 22, 2017 5:46 pm

willthrill81 wrote: If there was a significant possibility of upside potential with current EE bonds (7.5% would have me dancing right now :D), the entire equation would change. But a guaranteed .1% or 3.5% if you leave it tied up for twenty years just doesn't do it for me. I can't help but believe strongly that there are many other ways to earn (1) a better return with (2) more liquidity. The guarantee is what really gets some people, and I do understand that, but like most guarantees, it doesn't guarantee you much.
About the time that EE bonds had a guaranteed minimum yield of 7.5%, which was about the time they were introduced, inflation had been over 10%. The yield on those EE bonds was less than inflation had been about that time. Similarly, the fixed rate on current EE bonds is less than inflation has been about this time.

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sat Apr 22, 2017 6:56 pm

mhop 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.
Kevin
Curious. This money is not new money though is it? It was pooled from other IRAs with CDs paying what % over what terms? The analysis doesn't necessarily start today unless it's new money. So we know you're comfortable at 3% for the next 7 years, but you may have made a decision 3-5 years ago as well that could add more detail.
I don't think I agree with what you're saying, but it motivated me think about the tradeoff between putting $10K or $20K into a 5-year CD in a taxable account today vs. an EE bond. First though, here are some thoughts on your comments.

I don't know what you mean by new money, and I don't know what difference it makes. If by new money you mean earned income, then I don't have any, because I'm retired.

The analysis for any investment begins on the day you buy it. It doesn't matter where the money came from or what that money was doing in the past. We don't have time machines, so we can't make decisions about what to invest in in the past.

The money I put into the 3% CD most recently did happen to be in an IRA, but I also bought some 3% CDs a few years ago in a taxable account. These investments aren't really comparable in terms of scale, since I bought a lot more of the CDs than I could have bought of EE bonds due to the annual purchase limits.

That brings us back to the decision I'd think about if I had $10K or $20K (I could buy an additional $10K with my living trust) looking for a longish-term fixed-income home (which I don't).

As of right now, I don't know of any 3% CDs, but I could buy a 5-year CD at 2.75% with an early withdrawal penalty of six months of interest. I would compare this to a 5-year Treasury at 1.77%, and conclude that it's an excellent deal, with a yield premium of almost 100 basis points, which is a little less than my average for CDs purchased over the last 6+ years.

When this CD matured, I might not reinvest it in another CD. If my stocks were below target, I might use it to buy stocks. Or I might spend it. I did some of each with the proceeds from a big batch of taxable CDs that matured in late 2015. But for the sake of comparison, let's say I roll it into 5-year CDs until I hit the 20-year mark when the EE bond would have doubled before tax.

Assuming a constant 25% marginal tax rate, the $10K EE bond is worth $1,750 after tax. So this is what I'd need to beat with the CDs, paying the tax every year. For example, 2.75% after 25% tax is 2.06%. The following sequence of CD APYs would beat the EE bond, resulting in an after-tax value of 17,569. After-tax yields are shown in parentheses.

2.75% (2.06%)
3.50% (2.63%)
4.25% (3.19%)
4.75% (3.56%)

Given that we've seen several 7-year 3% CD deals in the last few years, getting 3.5% in five years seems very reasonable. Getting 4.25% in 10 years and 4.75% in 15 years seems less certain, but having spent a lot of my adult life earning 5% or more in money market funds, I just have a hard time accepting that we're going to be stuck with the low rates we've been stuck with since the financial crisis (the 5-year Treasury was above 5% as recently as July 2007).

Of course I could be wrong. In a recent post, I shared a link to a blog post buy Ben Bernanke, in which he discussed research indicating that short-term rates could be close to 0% as much as 30-40% of the time going foward: How big a problem is the zero lower bound on interest rates? - Bogleheads.org. If that turns out to be the case, then the EE bond may indeed turn out to be the fixed-income winner over the next 20 years.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sat Apr 22, 2017 7:08 pm

and some of us plan to tax rate arbitrage the EEs, in my case from 35% marginal to perhaps 25% marginal in 20 years. kevin, what rates what a CD have to earn to compare to an EE for someone like me?

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sat Apr 22, 2017 7:31 pm

letsgobobby wrote:what if you expected inflation to be 1% over the next 20 years?
Depends how that happened. But a steady 1% would be pretty odd, seeing as how the Fed's target is more like 2%. So if you just told me inflation was going to average 1% for the next 20 years, but nothing else, my guess would be that means there would be at least one really serious deflationary event somewhere along the way.

So if that is all I knew, I would buy normal nominal long bonds, so that whenever that event showed up, I would have a big increase in real wealth I could then use as I saw fit.

User avatar
knpstr
Posts: 1827
Joined: Thu Nov 20, 2014 8:57 pm
Location: Michigan

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

Post by knpstr » Sat Apr 22, 2017 7:56 pm

FWIW, comparing bonds and stocks is NOT ridiculous at all. All of our choices must be compared against all available alternatives as all of our choices are inextricably linked by opportunity cost.

In popular terms, the chief "benefit" of bonds and "risk" to stocks is volatility (or lack thereof).
Over a long holding period with no desire to withdraw money, say 20 years, volatility is irrelevant as a risk factor to stocks and in truth is somewhat a benefit.
In this respect, it is not only not ridiculous, but it is wise to directly compare the two. As well as other options for one to allocate their capital.

:beer
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sat Apr 22, 2017 8:05 pm

letsgobobby wrote:and some of us plan to tax rate arbitrage the EEs, in my case from 35% marginal to perhaps 25% marginal in 20 years. kevin, what rates what a CD have to earn to compare to an EE for someone like me?
Yes, that makes it more attractive.

Assuming you start at 2.75% with marginal tax rate of 35% for the first 15 years and 25% for the last five years, an increase of about 94 basis points every five years would just beat the EE bond. For example, that would mean an APY of 5.57% for the CD bought at the beginning of year 16.

Of course the EE bond is exempt from state income tax, so if in a high tax state, the EE bond has even more of an edge.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

WolfgangPauli
Posts: 170
Joined: Sun Aug 23, 2015 8:28 am

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

Post by WolfgangPauli » Sat Apr 22, 2017 10:07 pm

knpstr wrote:FWIW, comparing bonds and stocks is NOT ridiculous at all. All of our choices must be compared against all available alternatives as all of our choices are inextricably linked by opportunity cost.

In popular terms, the chief "benefit" of bonds and "risk" to stocks is volatility (or lack thereof).
Over a long holding period with no desire to withdraw money, say 20 years, volatility is irrelevant as a risk factor to stocks and in truth is somewhat a benefit.
In this respect, it is not only not ridiculous, but it is wise to directly compare the two. As well as other options for one to allocate their capital.

:beer
I agree as long as you are appropriately valuing the increase in risk. So, for example, a EE bond is essentially risk free. Yes, compare to stocks but you must calculate in the risk of owning stocks. And, of course, you may not desire to withdraw for 20 years but you may have to (emergencies etc.). What I find is people compare the two and yet have no discussion on risk profile.
Twitter: @JAXbogleheads | EM: JAXbogleheads@gmail.com

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 10:17 pm

FactualFran wrote:
willthrill81 wrote: If there was a significant possibility of upside potential with current EE bonds (7.5% would have me dancing right now :D), the entire equation would change. But a guaranteed .1% or 3.5% if you leave it tied up for twenty years just doesn't do it for me. I can't help but believe strongly that there are many other ways to earn (1) a better return with (2) more liquidity. The guarantee is what really gets some people, and I do understand that, but like most guarantees, it doesn't guarantee you much.
About the time that EE bonds had a guaranteed minimum yield of 7.5%, which was about the time they were introduced, inflation had been over 10%. The yield on those EE bonds was less than inflation had been about that time. Similarly, the fixed rate on current EE bonds is less than inflation has been about this time.
Since my Delorean is in the shop, I can't travel back to when EE bonds were paying 7.5% and invest that money. But even if I could, with 20/20 hindsight, I would put it in Apple and now own my own private island somewhere. :D
knpstr wrote:FWIW, comparing bonds and stocks is NOT ridiculous at all. All of our choices must be compared against all available alternatives as all of our choices are inextricably linked by opportunity cost.

In popular terms, the chief "benefit" of bonds and "risk" to stocks is volatility (or lack thereof).
Over a long holding period with no desire to withdraw money, say 20 years, volatility is irrelevant as a risk factor to stocks and in truth is somewhat a benefit.
In this respect, it is not only not ridiculous, but it is wise to directly compare the two. As well as other options for one to allocate their capital.

:beer
:sharebeer

That was my original point. While there are no guarantees, there has been only been a single 20 year period in the historic record of stocks not returning a nominal 3.5% (still 3.0%). In every other case, stocks came out ahead, usually FAR ahead. So to the extent that the future looks like the past, the downside potential over 20 years with stocks is very low, whereas the upside is very high. With current EE bonds, the upside potential is very low, but the downside is significant.

Historically speaking, the price for the guarantee in this situation is very high.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
jimb_fromATL
Posts: 2193
Joined: Sun Nov 10, 2013 12:00 pm
Location: Atlanta area & Piedmont Triad NC and Interstate 85 in between.

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

Post by jimb_fromATL » Sat Apr 22, 2017 10:41 pm

Earl Lemongrab wrote: If you buy 10k each year and hold 20 years, the tax-deferred amount is $350 total over the 20 years each time. If you bought them 20 years running, the total would be about $7000. That's about 1.5 years worth of IRA contributions for a young person. I consider that small.

Maybe I'm misunderstanding what you're saying, but you're guaranteed to double your money in 20 years with EE bonds. That's $10K gain on a $10K purchase.

It is an average APY of 3.5%, but that $350 is only the equivalent interest for the first year of the purchase. It increases each year with semi-annual compounding, an average of $500 per year and total of $10,000 earnings on a $10,000 purchase in 20 years, with taxes deferred.

And that's for each year. So for 20 rolling years of $10K purchases, you would be deferring taxes on a total of $200,000 in earnings on $200,000 invested.
Again, you better be in a lower tax bracket in 20 years or you'll get very little advantage because you'll need to cash them at a high rate or have that 3.5% rate start dropping. For me, not worth it. But then I have over $1 million in tax-advantaged these days, so things can seem small to me that don't to others.
Since the max you can buy is $10K per year, EE bonds would be only a small part of a million buck portfolio. But a lot of folks allocate some of their portfolio to stable value funds anyway. For that portion, 3.5% absolutely guaranteed with taxes deferred for 20 years or more ain't bad at all. Even better if you live where you would also avoid the state tax on the earnings on EE bonds.

jimb

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 10:52 pm

WolfgangPauli wrote:
knpstr wrote:FWIW, comparing bonds and stocks is NOT ridiculous at all. All of our choices must be compared against all available alternatives as all of our choices are inextricably linked by opportunity cost.

In popular terms, the chief "benefit" of bonds and "risk" to stocks is volatility (or lack thereof).
Over a long holding period with no desire to withdraw money, say 20 years, volatility is irrelevant as a risk factor to stocks and in truth is somewhat a benefit.
In this respect, it is not only not ridiculous, but it is wise to directly compare the two. As well as other options for one to allocate their capital.

:beer
I agree as long as you are appropriately valuing the increase in risk. So, for example, a EE bond is essentially risk free. Yes, compare to stocks but you must calculate in the risk of owning stocks. And, of course, you may not desire to withdraw for 20 years but you may have to (emergencies etc.). What I find is people compare the two and yet have no discussion on risk profile.
I know of no people on this forum who blindly compare stocks and bonds with no attention to risk.

In this context, we must consider the volatility of stocks over a 20 year period rather than the typical "stocks could drop 50% in a year." Over long periods of continual investment, the likelihood of a positive outcome increases dramatically. People sometimes talk about stock returns still being volatile over twenty year periods, which they are, but the volatility is all on the positive side, and it becomes a question of whether the annual return is 3% or 15%, for instance.

Check out the graphic at this site for an impressive visual demonstration of this.
https://ofdollarsanddata.com/just-keep- ... 31402231c9
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sat Apr 22, 2017 10:57 pm

WolfgangPauli wrote:I agree as long as you are appropriately valuing the increase in risk. So, for example, a EE bond is essentially risk free.
To be clear, they are (we hope) free from credit risk. There are all sorts of other risks associated with EE bonds, however.
And, of course, you may not desire to withdraw for 20 years but you may have to (emergencies etc.).
Exactly! If you have an unplanned need to withdraw prior to 20 years, EE bonds are punitive. This should count as a big risk in any analysis of EE bonds.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 11:01 pm

jimb_fromATL wrote: Since the max you can buy is $10K per year, EE bonds would be only a small part of a million buck portfolio. But a lot of folks allocate some of their portfolio to stable value funds anyway.
It's not available to everyone, but I personally would pass on EE bonds in lieu of TIAA Traditional every time that I wanted a guaranteed outcome. Currently, the 'supplemental' version pays a guaranteed 3.25% with full liquidity, and the 'regular' version pays a guaranteed 4.0% currently, though it takes ten years of 1/10 plus interest payments to withdraw the funds. And with both of these versions, there is upside potential as rates increase. And you can deposit a whole lot more than $10k (not sure offhand, but I think the maximum is $5 million).

There are many roads to Dublin.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

bhough
Posts: 46
Joined: Wed Feb 15, 2017 6:53 pm

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

Post by bhough » Sat Apr 22, 2017 11:02 pm

I think every point has already been made here (twice) so this might be redundant, but I'll tell you why I buy them.

1. I have come to learn that I need some bonds in my asset allocation (four pillar book my friend made me read)
2. Prior to this epiphany, I was 100% stocks (and private real estate)
3. I am expecting interest rate risk from bond funds (drop in price of bonds in fund when/if interest rates rise) in the future
4. I don't need this money for > 20 years. It will either be in a bond fund or in EE bonds (have already maxed out tax advantaged and I bonds for myself and spouse)
5. I will likely be in a lower tax bracket then (and if not, great news!)
6. There is no cost to purchase EE bonds
7. There is no yearly cost to hold EE bonds
8. There is no cost to sell EE bonds
9. I thought of tying $10,000 in rubber bands and putting it in my safe deposit box when I started reading in the WSJ about Japanese and German banks charging negative interest. EE bonds are better than cash in a safe deposit box for deflation risk.
10. The earnings are tax deferred, whereas TIPS and CDs are taxed yearly
11. There is no call risk
12. Compared to non-government bond funds, they are protected by the full faith of the US government. If you purchase a corporate bond fund, the individual bonds in that fund are subject to default risk.
13. I am hedged already against inflation risk with RE, stocks, and I bonds.
14. I am surprised by how happy the stability of bonds makes me feel. I originally thought I was a 100% guy, but am starting to realize that I'm probably a 80/20 guy. I don't think I would have learned this without buying these and interacting with treasurydirect.gov
15. I'm small potatoes to some of you on here, but what is the harm in putting 10% of your bond allocation to EE bonds (after some similar or large portion to I bonds)? It has unique properties that bond funds don't have and given the unpredictable nature of the future, why not hedge your risks? Since we can't buy $50,000/year of EE bonds, we are kind of splitting hairs a little. I've learned from my wife that it doesn't have to be 100% of one thing and 0% of another. It can be 83% of your bond allocation to I bonds and Tips, 10% to a corporate bond fund and 7% to EE bonds.

I realize this is a niche market and most people don't benefit from this investment product. However, given the above, I felt EE bonds were superior to TIPS, CDs, and bond funds for me. I would be grateful if someone corrects my thinking so I can invest more profitably.
thanks

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sat Apr 22, 2017 11:22 pm

bhough wrote:I think every point has already been made here (twice) so this might be redundant, but I'll tell you why I buy them.

1. I have come to learn that I need some bonds in my asset allocation (four pillar book my friend made me read) No disputing that.
2. Prior to this epiphany, I was 100% stocks (and private real estate)
3. I am expecting interest rate risk from bond funds (drop in price of bonds in fund when/if interest rates rise) in the future That's very reasonable.
4. I don't need this money for > 20 years. It will either be in a bond fund or in EE bonds (have already maxed out tax advantaged and I bonds for myself and spouse) Considering that this money has a 20 year horizon, why would you not consider alternatives? We've talked about stocks, but there are many other investments out there that would be volatile in the short-term but extremely likely to produce far higher returns over a two decade period.
5. I will likely be in a lower tax bracket then (and if not, great news!) This could also impact LTCG tax rates. It's very possible that you could buy shares of Berkshire Hathaway, receive no dividends (since they don't pay any), and pay no LTCG at all when you sell if you're in the 15%
bracket or lower.

6. There is no cost to purchase EE bonds There is no cost or very little to purchase many assets.
7. There is no yearly cost to hold EE bonds There is no cost or very little to own many assets.
8. There is no cost to sell EE bonds There is no cost or very little to sell many assets.
9. I thought of tying $10,000 in rubber bands and putting it in my safe deposit box when I started reading in the WSJ about Japanese and German banks charging negative interest. EE bonds are better than cash in a safe deposit box for deflation risk. The same could be said of any long-term bond.
10. The earnings are tax deferred, whereas TIPS and CDs are taxed yearly Many other investments can be tax deferred.
11. There is no call risk The same could be said of other types of bonds.
12. Compared to non-government bond funds, they are protected by the full faith of the US government. If you purchase a corporate bond fund, the individual bonds in that fund are subject to default risk. True, but there are other government-backed bonds too.
13. I am hedged already against inflation risk with RE, stocks, and I bonds. Just because you are hedged against inflation risk with other assets doesn't mean you should ignore inflation risk with EE bonds.
14. I am surprised by how happy the stability of bonds makes me feel. I originally thought I was a 100% guy, but am starting to realize that I'm probably a 80/20 guy. I don't think I would have learned this without buying these and interacting with treasurydirect.gov If they make you feel good and you can't feel good without them, then you should buy them.
15. I'm small potatoes to some of you on here, but what is the harm in putting 10% of your bond allocation to EE bonds (after some similar or large portion to I bonds)? It has unique properties that bond funds don't have and given the unpredictable nature of the future, why not hedge your risks? Since we can't buy $50,000/year of EE bonds, we are kind of splitting hairs a little. I've learned from my wife that it doesn't have to be 100% of one thing and 0% of another. It can be 83% of your bond allocation to I bonds and Tips, 10% to a corporate bond fund and 7% to EE bonds. It's true that the amount of money at stake is not significant, but that belies the point that the upside potential of EE bonds is very low, but the downside risks from inflation and opportunity cost of higher return assets are very high.

I realize this is a niche market and most people don't benefit from this investment product. However, given the above, I felt EE bonds were superior to TIPS, CDs, and bond funds for me. I would be grateful if someone corrects my thinking so I can invest more profitably.
thanks
Be careful to not get caught up in the thinking that "I need bonds just because I do." Bonds are merely a means to an end and not the end itself. If you have strong evidence that points to a better risk-adjusted investment over a given time frame, you should take it whether it's another flavor of bond or something else altogether.

For instance, once your portfolio reaches a certain size, say double or triple what you realistically want to meet your needs, you could easily drop bonds altogether and go 100% stocks. Even if stocks dropped 50% and languished there for a while, you'd still be perfectly fine because your portfolio would still be big enough to handle it. A good argument can be made that bonds are for the money that you can't afford to lose; once this goal has been met, many do not purchase any more, regardless of their portfolio's size.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sun Apr 23, 2017 12:58 am

you say you do own bonds. What bonds (or fixed income) do you own, and what percentage of your portfolio are they?

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 6:57 am

bhough wrote:I think every point has already been made here (twice) so this might be redundant, but I'll tell you why I buy them.

1. I have come to learn that I need some bonds in my asset allocation (four pillar book my friend made me read)
2. Prior to this epiphany, I was 100% stocks (and private real estate)
3. I am expecting interest rate risk from bond funds (drop in price of bonds in fund when/if interest rates rise) in the future
4. I don't need this money for > 20 years. It will either be in a bond fund or in EE bonds (have already maxed out tax advantaged and I bonds for myself and spouse)
5. I will likely be in a lower tax bracket then (and if not, great news!)
6. There is no cost to purchase EE bonds
7. There is no yearly cost to hold EE bonds
8. There is no cost to sell EE bonds
9. I thought of tying $10,000 in rubber bands and putting it in my safe deposit box when I started reading in the WSJ about Japanese and German banks charging negative interest. EE bonds are better than cash in a safe deposit box for deflation risk.
10. The earnings are tax deferred, whereas TIPS and CDs are taxed yearly
11. There is no call risk
12. Compared to non-government bond funds, they are protected by the full faith of the US government. If you purchase a corporate bond fund, the individual bonds in that fund are subject to default risk.
13. I am hedged already against inflation risk with RE, stocks, and I bonds.
14. I am surprised by how happy the stability of bonds makes me feel. I originally thought I was a 100% guy, but am starting to realize that I'm probably a 80/20 guy. I don't think I would have learned this without buying these and interacting with treasurydirect.gov
15. I'm small potatoes to some of you on here, but what is the harm in putting 10% of your bond allocation to EE bonds (after some similar or large portion to I bonds)? It has unique properties that bond funds don't have and given the unpredictable nature of the future, why not hedge your risks? Since we can't buy $50,000/year of EE bonds, we are kind of splitting hairs a little. I've learned from my wife that it doesn't have to be 100% of one thing and 0% of another. It can be 83% of your bond allocation to I bonds and Tips, 10% to a corporate bond fund and 7% to EE bonds.

I realize this is a niche market and most people don't benefit from this investment product. However, given the above, I felt EE bonds were superior to TIPS, CDs, and bond funds for me. I would be grateful if someone corrects my thinking so I can invest more profitably.
thanks
So I would start with the observation that 1 and 4 seem potentially contradictory to me. Why exactly do you need bonds? Most of the common reasons in one way or another imply the possibility of actually needing to access that money. For example, we discussed 9 above. EE bonds are BARELY better than paper money in the case you actually need them in a deflationary scenario. You'd be better off with normal nominal long bonds, or with cash in a money market account.

Just reading through your list, maybe the answer is 14--the psychological benefit. And maybe 3 explains why you don't like regular long bonds for that purpose.

The thing is, this is just a mental trick. If interest rates rise, the real value of your EE bonds will fall. Because you CAN'T redeem them early for full expected value, and must hold on to them until they double or else suffer a big penalty, you apparently are going to ignore this loss of real value in your mental accounting. But it did in fact happen--you just aren't letting yourself notice it happened.

And if that works for you, then OK. But I'll admit to being skeptical. Suppose inflation goes up to 3.5%. Are you really not going to notice your EE bonds now have 0% real return? What if long term rates are now 5%? You're not going to notice your EE bonds are returning a lot less than that? Of course the later this happens, the higher the implied return on EE bonds for the remainder of your time holding them. But if it happens earlier rather than later, you might well wish you had invested in something else which would allow you to track rates upward.

But hey, it is your psychology, so you might be right. But for the reasons I have given, I don't think EE bonds are actually a good hedge against deflation risk, and otherwise they are exposed to all sorts of other risks. And if benefiting from them relies on you maintaining your ignorance about what rising rates would mean for the real value of your EE bonds, I'd be concerned that benefit would disappear if and when it is seriously put to the test.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Apr 23, 2017 8:56 am

letsgobobby wrote:you say you do own bonds. What bonds (or fixed income) do you own, and what percentage of your portfolio are they?
I'm guessing that this is directed toward me.

Both the question and the answer are germane to this thread and off topic.

However, I know of many Bogleheads who are very bond heavy and would never consider EE bonds at current yields.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sun Apr 23, 2017 10:17 am

WolfgangPauli wrote:So, for example, a EE bond is essentially risk free.
This is not true. What is true is that EE bonds have essentially no credit risk. But credit risk is only one dimension of fixed-income risk, the other primary dimension being term risk (term risk incorporates inflation risk if you think about it in real terms). EE bonds have very high term risk, as does any 20-year zero-coupon bond (EE bond fixed rate is low enough that we can approximate it as 0%). The EE bond does have the put option that limits the downside risk (if redeemed before 20 years), but it also doesn't have the upside risk of a standard zero-coupon bond (which could pay off for the standard zero if interest rates fell).

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sun Apr 23, 2017 10:23 am

willthrill81 wrote:
letsgobobby wrote:you say you do own bonds. What bonds (or fixed income) do you own, and what percentage of your portfolio are they?
I'm guessing that this is directed toward me.

Both the question and the answer are germane to this thread and off topic.

However, I know of many Bogleheads who are very bond heavy and would never consider EE bonds at current yields.
confused, because you say the question is both germane and off topic, which is inherently contradictory:

http://www.thefreedictionary.com/germane

You say repeatedly we should compare EE bonds to the alternative available investments, and I agree. You say EE bonds are unattractive to you; fine. But please tell me what alternative fixed income investments you have chosen for yourself, and therefore must believe are superior to EE bonds.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Apr 23, 2017 10:39 am

letsgobobby wrote:
willthrill81 wrote:
letsgobobby wrote:you say you do own bonds. What bonds (or fixed income) do you own, and what percentage of your portfolio are they?
I'm guessing that this is directed toward me.

Both the question and the answer are germane to this thread and off topic.

However, I know of many Bogleheads who are very bond heavy and would never consider EE bonds at current yields.
confused, because you say the question is both germane and off topic, which is inherently contradictory:

http://www.thefreedictionary.com/germane

You say repeatedly we should compare EE bonds to the alternative available investments, and I agree. You say EE bonds are unattractive to you; fine. But please tell me what alternative fixed income investments you have chosen for yourself, and therefore must believe are superior to EE bonds.
A slip of the tongue, or fingers. :oops:

I've already said that I believe virtually any other bonds to be superior to EE bonds. Certainly the yields are lower, but the major factor is that they aren't tied up for twenty years. Bonds are purchased almost entirely for their ability to reduce volatility, not because of their 'guaranteed' returns.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sun Apr 23, 2017 10:48 am

bhough wrote:3. I am expecting interest rate risk from bond funds (drop in price of bonds in fund when/if interest rates rise) in the future
If interest rates increase enough, you will do better with rolling 5-year CDs for 20 years, as I discussed earlier.
5. I will likely be in a lower tax bracket then (and if not, great news!)
I showed an example in which rolling 5-year CDs would come out better if the best available 5-year CD rate increased by less than one percentage point every five years (e.g., 5-year now is 2.75%, and if five years would be 3.75%) if your marginal tax rate now is 35% and would be 25% when you redeemed your EE bond.
6. There is no cost to purchase EE bonds
7. There is no yearly cost to hold EE bonds
8. There is no cost to sell EE bonds
Ditto for CDs bought directly from banks and credit unions.
10. The earnings are tax deferred, whereas TIPS and CDs are taxed yearly
The tax deferral can be quantified, and should be part of your analysis. TIPS and CDs can be held in tax-advantaged accounts, and either be tax-deferred or not taxed at all.
11. There is no call risk
12. Compared to non-government bond funds, they are protected by the full faith of the US government. If you purchase a corporate bond fund, the individual bonds in that fund are subject to default risk.
Direct CDs do have a small amount of call risk, since the bank or credit union could fail, and you could receive your principal and interest to date of failure before maturity. However, if you look at bank failure rates, this is a tiny risk, especially if you don't buy from low-rated banks.

Of course CDs also have no credit risk if you stay within the federal deposit insurance limits, which of course are much higher than we need to consider in comparing to EE bonds, with their annual purchase limits.
15. I'm small potatoes to some of you on here, but what is the harm in putting 10% of your bond allocation to EE bonds (after some similar or large portion to I bonds)? It has unique properties that bond funds don't have and given the unpredictable nature of the future, why not hedge your risks? Since we can't buy $50,000/year of EE bonds, we are kind of splitting hairs a little. I've learned from my wife that it doesn't have to be 100% of one thing and 0% of another. It can be 83% of your bond allocation to I bonds and Tips, 10% to a corporate bond fund and 7% to EE bonds.
True, a small allocation to EE bonds won't hurt you much, but neither will it help you much. With 7% of a 20% bond allocation in EE bonds, that's 1.4% of the portfolio in EE bonds. That's not much of a hedge against whatever risks EE bonds are hedging (e.g., deflation). Same goes for TIPS and I Bonds--a small allocation isn't going to help much if we see high unexpected inflation.

Funny you mentioned that you can't buy $50,000 of EE bonds, since I realized that my wife and I could buy $50K/year of EE bonds (and ditto for I Bonds). Between us we have three living thrusts, so we could buy $10K each as individuals, and $10K for each for our living trusts; that's $50K. Even at that rate, it would take five years to buy as much as we can cover for CDs with federal deposit insurance in an IRA, 10 years to buy as much as we can cover with FDIC insurance in a joint account, and 25 years to buy as much as we can cover with FDIC insurance with a trust or POD account with five beneficiaries.

We could bump the $50K to $100K if we think intergenerationally, and buy $10K each for our five children, or even $130K if we include children's spouses and children (in a few months that would be $150K). So if we really liked EE bonds, we actually could acquire a meaningful amount in a few years.

For a young person with a small portfolio, who's only retirement savings otherwise go into a 401k and/or an IRA, $10K per year is a meaningful amount. But most of these people probably should be buying mostly stocks.
I realize this is a niche market and most people don't benefit from this investment product. However, given the above, I felt EE bonds were superior to TIPS, CDs, and bond funds for me. I would be grateful if someone corrects my thinking so I can invest more profitably.
thanks
I think if you are really concerned about interest-rate risk (term risk), and you understand that CDs have many of the benefits you list for EE bonds, then rolling 5-year CDs could be a superior choice for you. But with only 20% of your portfolio in fixed-income, and only a portion of that in EE bonds, it just doesn't matter much.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sun Apr 23, 2017 11:40 am

Kevin, you said rolling 5 year CDs could be a better choice for the above poster, but in response to my question above, you indicated rates would need to be quite a bit higher, or:

2.75% now
3.68% in 5 years
4.61% in 10 years
5.57% in 15 years

Obviously we can't predict the future but with 30 year treasuries offering 2.89%... none of those rates are guaranteed; in my opinion they seem quite unlikely (just my opinion, of course).

EE bonds are attractive if we remain in a low rate, low inflation world. And that doesn't seem unlikely.
willthrill81 wrote:Bonds are purchased almost entirely for their ability to reduce volatility, not because of their 'guaranteed' returns.
you keep saying this, but your statement is incomplete. That may be ONE reason investors buy bonds, but it is hardly the only. For instance, I have a very high risk tolerance and am not afraid of volatility at all. That's not why I buy bonds. That's also why I don't value liquidity (in this portion of my portfolio). I buy bonds for the guaranteed returns, either nominal or inflation-adjusted at the end of a specific term. I am willing to sacrifice expected return in exchange for this guarantee, 20 years (or whatever the term may be) later. It would help if you had a broader mind as to the different roles different investments play for different investors.

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sun Apr 23, 2017 12:39 pm

letsgobobby wrote:Kevin, you said rolling 5 year CDs could be a better choice for the above poster, <snip>
Yes, "could be", given the concern about rising interest rates, which was one of the many points listed. Just wanted that poster to understand that EE bonds may not be the best choice if the concern is rising interest rates, and that rolling 5-year CDs would be better if interest rates increased enough.
... but in response to my question above, you indicated rates would need to be quite a bit higher, or:

2.75% now
3.68% in 5 years
4.61% in 10 years
5.57% in 15 years
Yes, which is why I said that it would require an increase of less than one percentage point every five years for the CDs to come out better. It's up to the poster to estimate the rising rate scenario that is of concern.
Obviously we can't predict the future but with 30 year treasuries offering 2.89%... none of those rates are guaranteed; <snip>
Yes, if you consider only the expectations hypothesis to explain the yield curve (and ignore the liquidity preference theorem; i.e., that term risk also is an explanatory factor), then we wouldn't expect rolling 5-year Treasuries to do any better than buying and holding a 20-year Treasury to maturity. But, I would add 100 basis points to the 5-year Treasury yield, since that's less than my average yield premium for CDs. That still doesn't get you there, but the expectations hypothesis has been woefully inadequate in successfully predicting yield curve changes, so I don't consider the current 20-year Treasury yield to be a good predictor of what you'll earn by rolling 5-year Treasuries for 20 years.
... in my opinion they seem quite unlikely (just my opinion, of course).

EE bonds are attractive if we remain in a low rate, low inflation world. And that doesn't seem unlikely.
In which case, the decision to buy EE bonds is right for you.

You are far from alone in believing that it's likely that we'll remain in a low-rate, low-inflation world. I understand some of the arguments for that, but also am concerned about how much recency bias affects that perception.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 12:42 pm

letsgobobby wrote:I buy bonds for the guaranteed returns, either nominal or inflation-adjusted at the end of a specific term.
Exactly why is a guaranteed nominal return in 20 years valuable?

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sun Apr 23, 2017 12:57 pm

NiceUnparticularMan wrote:
letsgobobby wrote:I buy bonds for the guaranteed returns, either nominal or inflation-adjusted at the end of a specific term.
Exactly why is a guaranteed nominal return valuable?
The same reason many people buy SPIAs, or like to have non-COLA pensions, or frankly, buy any nominal corporate or government bond: certainty.

guaranteed real returns are nicer, but that additional guarantee costs something. The purchase price of an inflation-adjusted SPIA is higher than the purchase price of a non-adjusted SPIA. The initial payment of a COLA pension is lower than the initial payment of a non-COLA pension. I bonds currently have a guaranteed negative real return net of taxes (assuming one pays federal taxes).

As compared to marketable bonds, the really distinguishing feature of EE bonds is not their nominal guarantee but rather their lack of liquidity. In my opinion, their higher yield compensates for that reduced liquidity because I place little value on liquidity. I get government-issued, risk free returns of 3.5%, which is about a 1% premium compared to a 20 year government bond.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Apr 23, 2017 2:04 pm

letsgobobby wrote:you keep saying this, but your statement is incomplete. That may be ONE reason investors buy bonds, but it is hardly the only. For instance, I have a very high risk tolerance and am not afraid of volatility at all. That's not why I buy bonds. That's also why I don't value liquidity (in this portion of my portfolio). I buy bonds for the guaranteed returns, either nominal or inflation-adjusted at the end of a specific term. I am willing to sacrifice expected return in exchange for this guarantee, 20 years (or whatever the term may be) later.
I've told you already that I understand why you like them. But it doesn't change my assessment of the risk-adjusted return being very poor.
letsgobobby wrote:It would help if you had a broader mind as to the different roles different investments play for different investors.
That's a bit of a presumptuous statement. I understand very well that different investment vehicles have different roles for different people in different points in time. Once again, though, that does not mean that everything is an appropriate investment.

I'm not alone at all in my assessment of long-term bonds in the current environment.

Please see this snippet from an excellent Forbes article on the topic of long-term bonds.

"Let’s say we meet Harry at a party. When conversation turns to bond investing, Harry says: “If I buy 30-year Treasuries today, I’ll get 2.7% interest, and if I hold them to maturity I’ll get all of my principal back and interest, so I can’t lose. Why would I even consider buying 5-year Treasuries that yield 0.7% or 12-month T-bills that yield only 17 basis points?”

What’s wrong with Harry’s statement? First, consider the implications of purchasing a 30-year bond. Harry is effectively getting only one shot at predicting interest rates and inflation for the next 30 years (provided that he holds the bond for the full term). Compare that scenario to one where an investor purchases one-year maturity bonds. Here, he gets 30 shots at predicting interest rates over the same period, since he can reinvest the maturing bond principal at the end of each year (possibly at a higher rate)."

"Investors who lock into long-term bonds are taking on huge interest rate and inflation risk. A strategy of purchasing shorter-term bonds we believe provides a better risk-reward tradeoff and will be a particularly rewarding strategy during an extended period of rising rates."
https://www.forbes.com/sites/greggfishe ... ac1ab925ac

I'm not quite as negative toward long-term bonds in general as that author, but it's undeniable that they are risky investments, regardless of the guaranteed nominal return. Like Larry Swedroe has said many times, I believe that if we're going to take on risk, it should lean toward equities rather than bonds.
letsgobobby wrote:I get government-issued, risk free returns of 3.5%, which is about a 1% premium compared to a 20 year government bond.
That is bona fide false. Even if we assume that there is no credit risk (many would dispute that), there are many other risks at work.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

letsgobobby
Posts: 10695
Joined: Fri Sep 18, 2009 1:10 am

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

Post by letsgobobby » Sun Apr 23, 2017 2:30 pm

If you own any TBM, you own intermediate and long term bonds. Do you own any TBM? Many investors do; and the standard 3 or 4 fund Boglehead portfolio containts TBM as well. What I'm doing is simply replacing some portion of TBM with another high quality, long term bond, that happens to be less liquid than its direct competitors (20 year treasuries), but also far higher-yielding. Your strong stand against something so eminently reasonable befuddles me.

Now you may believe you can predict the future, and therefore can discard MPT and the founding principles of passive investing; but I don't. If I could predict the future, I would only invest in one asset class. I can't, so I invest in many.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

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

Post by willthrill81 » Sun Apr 23, 2017 3:16 pm

letsgobobby wrote:If you own any TBM, you own intermediate and long term bonds. Do you own any TBM? Many investors do; and the standard 3 or 4 fund Boglehead portfolio containts TBM as well. What I'm doing is simply replacing some portion of TBM with another high quality, long term bond, that happens to be less liquid than its direct competitors (20 year treasuries), but also far higher-yielding. Your strong stand against something so eminently reasonable befuddles me.

Now you may believe you can predict the future, and therefore can discard MPT and the founding principles of passive investing; but I don't. If I could predict the future, I would only invest in one asset class. I can't, so I invest in many.
As I said earlier (getting a bit tired of using that phrase in this thread), I'm not completely opposed to long-term bonds, but EE bonds are a unique form of long-term bond in that they must be held by you for twenty years to receive the stated 3.5% interest. This is not the case with LTT; they pay regular interest payments all along, and there is no penalty if they are sold before they mature. With EE bonds, you are stuck for twenty years unless you forego essentially all of your interest.

We're just going around in circles now. You clearly think these have a place in your portfolio, and that's fine. Observers just need to understand that while there may be no credit risk with this investment, there are potentially huge other risks at work, and the potential gain is small.

Peace out. :wink:
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Dead Man Walking
Posts: 509
Joined: Wed Nov 07, 2007 6:51 pm

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

Post by Dead Man Walking » Sun Apr 23, 2017 3:51 pm

Due to my age and health, I don't have a dog in this fight. However, I recently read an article about the affect of rising interest rates on financing the national debt. If rates were to rise significantly, the cost of financing the national debt would be astronomical. The authors concluded that rates would remain low because the government simply could not afford to finance the debt. I don't know if this is a realistic perspective, but the number of dollars in the calculations were beyond the comprehension of most mortals. It's probably as good an argument for continued low interest rates as any other. Sorry, but I can't recall the source of the article.

If continuing low interest rates are a consideration in your investment decisions, speculate at your own risk.

DMW

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 3:57 pm

letsgobobby wrote:The same reason many people buy SPIAs, or like to have non-COLA pensions
Those provide income you can spend before 20 years, and of course longevity insurance.
or frankly, buy any nominal corporate or government bond
Those are marketable without penalty, and will provide usable increases in value immediately during a deflationary event.

You don't get any of that with your EE bond, so again I ask what exactly is the value of a guaranteed nominal return in 20 years (but not sooner)?
As compared to marketable bonds, the really distinguishing feature of EE bonds is not their nominal guarantee but rather their lack of liquidity. In my opinion, their higher yield compensates for that reduced liquidity because I place little value on liquidity.
Yes, you've mentioned that you are disregarding the lack of liquidity, but you aren't answering my question. What exactly do you plan to do with your nominal return in 20 years, and why is that valuable to you?
Last edited by NiceUnparticularMan on Sun Apr 23, 2017 4:31 pm, edited 1 time in total.

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 4:05 pm

letsgobobby wrote:If you own any TBM, you own intermediate and long term bonds. Do you own any TBM? Many investors do; and the standard 3 or 4 fund Boglehead portfolio containts TBM as well.
I don't, personally. I see bonds as risk-management tools, and I have no desire to own bonds that don't serve my specific purposes.
What I'm doing is simply replacing some portion of TBM with another high quality, long term bond, that happens to be less liquid than its direct competitors (20 year treasuries), but also far higher-yielding.
Reaching for more yield in that particular way cancels out one of the few reasons for an individual investor to hold long bonds, namely to provide immediate benefit in the case of a deflationary event.

It is perfectly reasonable to ask those people who are willing to give up one of the main benefits of holding long bonds why they are doing that. A little more nominal yield appears to be the answer, but that just raises the question of why hold long bonds at all if you aren't going to get the main benefit they are supposed to provide.
Now you may believe you can predict the future, and therefore can discard MPT and the founding principles of passive investing; but I don't. If I could predict the future, I would only invest in one asset class. I can't, so I invest in many.
MPT does not imply every asset class is worth holding by every investor.

User avatar
knpstr
Posts: 1827
Joined: Thu Nov 20, 2014 8:57 pm
Location: Michigan

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

Post by knpstr » Sun Apr 23, 2017 5:22 pm

WolfgangPauli wrote:I agree as long as you are appropriately valuing the increase in risk. So, for example, a EE bond is essentially risk free. Yes, compare to stocks but you must calculate in the risk of owning stocks. And, of course, you may not desire to withdraw for 20 years but you may have to (emergencies etc.). What I find is people compare the two and yet have no discussion on risk profile.
I calculate that the long run lower expected return of EE bonds makes them more risky than stocks as measured by opportunity cost.
:beer
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

User avatar
Kevin M
Posts: 8883
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

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

Post by Kevin M » Sun Apr 23, 2017 6:46 pm

I think a rational reason for letsgobobby and others with beliefs like him to own EE bonds in preference to stocks for a 20-year time period is that, unlike willthrill81 and others with beliefs like him, he might believe that the last 90 years or so of US stock history is not an adequate sample on which to determine a probability distribution for stock returns over the next 20 years.

After all, we only have four independent 20-year samples, and the statisticians among us will tell us that it is not statistically valid to use rolling periods to try an gin up more samples--there is too much shared data between rolling samples (adjacent 20-year rolling samples have 19 years in common). Even those of us without a deep statistics education know that we can't have much confidence in any statistical conclusions based on four independent samples.

So even though there's only been one rolling 20-year period since 1926 when stocks had a nominal return of less than 3.5%, that doesn't necessarily mean that we should have high confidence that there won't be more such periods in the future--at least not based on just a statistical basis. If we start measuring in 1929, that's one independent (non overlapping) 20-year period out of four with a sub-3.5% return, so based on this small sample, that looks like about 25% odds that it could happen in the set of future independent 20-year periods.

There might be non-statistical reasons to have such confidence, like Warren Buffett's faith that owning a share of US businesses is virtually certain to be a better investment than bonds over a long time period, and I'd guess that 20 years would qualify for him as long enough.

I also think it's rational to hold a relatively small portion of one's fixed income in EE bonds. Although they have unique characteristics compared to the long-term Treasuries held in something like a total bond market fund (TBM), some of those unique characteristics are positive (higher yield, limited downside in nominal terms), and I can see how someone would conclude that those positives outweigh the negatives (only 0.1% if held for less than 20 years) for a portion of their fixed income.

I could see a very rational argument for holding both EE bonds and 20-year Treasuries (although I personally hold neither). The long-term Treasuries are likely to increase in value the most when stocks decrease in value the most during a financial crisis, as we saw in late 2008, so you could use the Treasuries to rebalance into stocks without having to touch your EE bonds. Then you might hold some I Bonds and/or TIPS to help offset the unexpected inflation risk of EE Bonds and long-term Treasuries. This isn't what I do, but it seems rational enough to me.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

User avatar
market timer
Posts: 5809
Joined: Tue Aug 21, 2007 1:42 am

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

Post by market timer » Sun Apr 23, 2017 7:10 pm

It's a long thread already, so here's my two cents:
1. Optionality: I can redeem my EE bonds if interest rates go up. It's like owning a 3.5% 20-year Treasury with a free put option.
2. Tax deferral / reduction: I'm in the 33% bracket now, but expect to have some years in the 0-15% bracket during early retirement, and might even use the bonds for my kids' educations tax free.
3. Yield: As mentioned, EE bonds yield more than comparable duration Treasuries.

Giving up liquidity for 20 years on this portion of my portfolio is not a problem. Whether stocks might return more than bonds over this period is also beside the point. I'd own long term bonds anyhow as part of a balanced portfolio, and EE bonds are a more efficient way of doing so.

When there is a flight to safety, where I'd have been tempted to sell long term Treasuries (such as Brexit last June), I short sell Treasury futures and keep holding my EE bonds.

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 7:18 pm

Kevin M wrote:Although they have unique characteristics compared to the long-term Treasuries held in something like a total bond market fund (TBM), some of those unique characteristics are positive (higher yield, limited downside in nominal terms), and I can see how someone would conclude that those positives outweigh the negatives (only 0.1% if held for less than 20 years) for a portion of their fixed income.
Ordinary long-term Treasuries have the same lack of downside in nominal terms if held to maturity.

So it seems to me it is really a question of whether the little bit of extra yield is worth the severe penalty in case you want to use them within 20 years. I don't see that making sense from a risk-management perspective, but I agree that if you are thinking nominal bonds might outperform stocks even over the long run, then perhaps.

My concern, though, is that perhaps some people are committing to a bond allocation percentages for risk-management reasons, then seeking higher yield because of the current pretty dismal yields, then forgetting why they had bonds in the first place and selling out the relevant attributes in the effort to squeeze out more yield. And I do wonder how these people will feel in practice if inflation and/or rates go up, or alternatively there is a deflationary scenario where they can't make use of their EE bonds without a severe penalty.

NiceUnparticularMan
Posts: 1740
Joined: Sat Mar 11, 2017 7:51 am

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

Post by NiceUnparticularMan » Sun Apr 23, 2017 7:23 pm

market timer wrote: 1. Optionality: I can redeem my EE bonds if interest rates go up. It's like owning a 3.5% 20-year Treasury with a free put option.
But you lose the 3.5% if you redeem them early.

It's more like owning a 20-year CD with a severe withdrawal penalty.

User avatar
triceratop
Moderator
Posts: 3784
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

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

Post by triceratop » Sun Apr 23, 2017 7:26 pm

market timer wrote:It's a long thread already, so here's my two cents:
1. Optionality: I can redeem my EE bonds if interest rates go up. It's like owning a 3.5% 20-year Treasury with a free put option.
2. Tax deferral / reduction: I'm in the 33% bracket now, but expect to have some years in the 0-15% bracket during early retirement, and might even use the bonds for my kids' educations tax free.
3. Yield: As mentioned, EE bonds yield more than comparable duration Treasuries.

Giving up liquidity for 20 years on this portion of my portfolio is not a problem. Whether stocks might return more than bonds over this period is also beside the point. I'd own long term bonds anyhow as part of a balanced portfolio, and EE bonds are a more efficient way of doing so.

When there is a flight to safety, where I'd have been tempted to sell long term Treasuries (such as Brexit last June), I short sell Treasury futures and keep holding my EE bonds.
The kids' education case is interesting. It looks like a good idea to start investing in EE bonds for education immediately upon planning to have kids: you'll want the bonds to reach original maturity (20 years) at age 18. Then you'll have a 10-year window mostly coinciding with child's higher education needs.

I wonder: for those with 529s how would one view these as part of an education portfolio, since one may not want to rebalance out of the EE bonds into equities. This is all theoretical for me as I am far from needing to consider it, though the problem is one I find interesting due to the generally fixed date of education funding needs.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

Post Reply