I-bond fixed rate = 0.3%

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Kevin M
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Re: I-bond fixed rate = 0.3%

Post by Kevin M » Thu May 03, 2018 9:54 am

Riley15 wrote:
Thu May 03, 2018 9:07 am
As a side question, while I know the SEC yield for TIPS is reported as real yield. Can anyone tell me if the average annual returns reported by Vanguard below are nominal or real returns? Seemed obvious until it wasn't.

https://personal.vanguard.com/us/funds/ ... true#tab=1
Nominal.

You can verify by viewing the annual returns with a [urlhttps://www.portfoliovisualizer.com/backtest-po ... ion1_1=100]Portfolio Visualizer backtest[/url], and comparing to the annual returns reported here: https://personal.vanguard.com/us/funds/ ... rue#tab=1a.

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Re: I-bond fixed rate = 0.3%

Post by Kevin M » Thu May 03, 2018 10:30 am

protagonist wrote:
Wed May 02, 2018 9:37 pm
And anywow, as you pointed out earlier in this thread, I-bonds are for taxable income and TIPS are predominantly for tax-advantaged income, so it is rare that one would have to choose between them.
(Good points in your reply, but I mainly want to address this one point)

I am in the position to choose between them. Note that I prefaced my point with the qualification that you have the flexibility to hold TIPS in an IRA, by which I meant that you have the flexibility to essentially shift assets between taxable and tax-advantaged accounts.

For example, I could sell my I Bonds and use the proceeds to buy Treasuries or municipal bonds in taxable (or CDs if the yields were high enough), then I could sell shares of one of my bond funds (or use proceeds from maturing IRA CDs) in an IRA to buy TIPs.

Every time one of these threads starts up, I take a look at the TIPS yields and think about this. The thing is that I'm not buying TIPS yet anyway, but favoring shorter-term nominal fixed-income, which historically usually has done a good job of beating inflation--I'm willing to accept the unexpected inflation risk for the higher expected risk-adjusted real return (factoring in the low term risk). I Bonds are a small enough portion of my portfolio, and the nominal return now is quite good for no term risk, that laziness wins out, and I just continue to hold them.

Regarding your other points, they are good ones. I Bonds and TIPS matched to the duration of my liabilities are much closer to risk-free assets than any nominal fixed income, so from a purely rational perspective, I probably should be using mostly TIPS for fixed income, and take my risk in equities. However, if I visualize this as an efficient-frontier/CAPM chart in real terms, with expected 3-year inflation at 2% or less and 3-year CDs in tax-advantaged space earning 2.9%, my fixed income is pretty close to the left side of the chart (the risk axis), and high enough above 0.3% expected real return (on the expected return axis) that I consider them a decent alternative for close to risk free, but with higher expected real return.

The annual purchase limits of I bonds restrict them to a tiny portion of my portfolio, so they provide no significant inflation protection from a portfolio perspective. And they would provide less than a year of liability matching, so I wouldn't end up owning any anyway if I were using them for liability matching. This is why it would have to be "mostly TIPS" instead of "TIPS and I Bonds" for me.

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Re: I-bond fixed rate = 0.3%

Post by protagonist » Thu May 03, 2018 1:15 pm

Kevin M wrote:
Thu May 03, 2018 10:30 am
with expected 3-year inflation at 2% or less
Kevin
Questions about this assumption:
1. Whose prediction is this?
2. How reliable, in general, have past short to intermediate range (say 2-5 years) predictions of inflation been? I ask that because I don't know, not because I am trying to make a point.

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Re: I-bond fixed rate = 0.3%

Post by Kevin M » Thu May 03, 2018 2:24 pm

protagonist wrote:
Thu May 03, 2018 1:15 pm
Kevin M wrote:
Thu May 03, 2018 10:30 am
with expected 3-year inflation at 2% or less
Kevin
Questions about this assumption:
1. Whose prediction is this?
2. How reliable, in general, have past short to intermediate range (say 2-5 years) predictions of inflation been? I ask that because I don't know, not because I am trying to make a point.
This was a guesstimate of the 3-year breakeven inflation rate based on the 5-year BIR. Currently I see 5-year nominal at 2.80% and 5-year TIPS at 0.71%, putting the 5-year BIR at about 2.1%. This is based on the treasury.gov yields, and no real yield is posted for less than 5-year maturity.

I see a TIPS maturing 4/14/2021 at 0.612%, but based on the wide spread of TIPS yields I posted earlier (still waiting for an explanation), I don't know how much weight to put on this. For example, I also see one maturing 7/15/2021 with yield of 0.448%. In this case, the coupon rate of the lower yielding TIPS is higher, so shortening duration relative to maturity. The inflation factor also is higher, resulting in a significantly higher adjusted price, which I guess explains the lower yield.

So maybe we could just call it about 0.5%. the 3-year treasury.gov quote is 2.64%, so perhaps 2.1% BIR is also a reasonable estimate for three years.

There are liquidity and unexpected inflation premiums/discounts (depending on how you look at it) for TIPS compared to nominal Treasuries, but these aren't observable, and they work in opposite directions, so my first-order assumption is to just ignore them. Some people also look at economist surveys, but I don't know how much value they add over the market expectations reflected in BIR.

I don't know the answer to the second question. One could do some analysis on it using BIR and CPI numbers from FRED. But there's uncertainty in most expected returns too (of course less if looking at safe fixed income held to maturity, nominal bonds for nominal returns and TIPS for real returns, and of course less for I Bonds for real returns whether held to maturity or not), so even if we use BIR for expected inflation, it's just the mean of a probability distribution.

One thing we can see from historical data is that short-term nominal fixed income typically does OK at responding to inflation--certainly much better than longer-term nominal fixed income--because nominal yields tend to increase with inflation, and with shorter-term nominal fixed income you are able to roll to the higher yields more quickly. There are exceptions, such as recent years when the Fed was holding short-term yields close to 0%, and also in earlier periods (1940s as I recall), when the US government capped government bond yields, including short-term yields (before TIPS existed).

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Re: I-bond fixed rate = 0.3%

Post by protagonist » Thu May 03, 2018 7:39 pm

I think people accept expert predictions too easily without looking into their past track record. Past track record in this case would not be too hard to analyze.

Stock market predictions are horrible, since the stock market is governed largely by complexity theory and nearly limitless variables, with exponential growth of noise vs signal over time ("exquisite sensitivity to initial conditions").

But one could make an argument that fed. interest rates and inflation are more predictable, at least in the vague sense, because they are largely manipulated based on economic and political realities to achieve a specific result- barring extreme unpredictable events some prediction might be accurate over a few years. And if one looks at treasury yields over the past 150 years or so , they have moved cyclically.....pretty much a few decades of rise followed by a few decades of fall etc. after one irons out the blips. So I was wondering if this has been analyzed retrospectively- just how much accuracy can we expect from 2-5 year inflation estimates? I would not be surprised if , over a relatively short time frame (such as 3 years), there was some , at least vague accuracy in past estimates.....ballpark anyway. But I don't know, and this is not my field or hobby so I am not the guy to do the research. I would be surprised if somebody, or many others, have not done it.
Last edited by protagonist on Sun May 06, 2018 10:28 am, edited 1 time in total.

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Re: I-bond fixed rate = 0.3%

Post by Kevin M » Thu May 03, 2018 8:14 pm

protagonist wrote:
Kevin M wrote:
Thu May 03, 2018 2:24 pm
protagonist wrote:
Thu May 03, 2018 1:15 pm
Kevin M wrote:
Thu May 03, 2018 10:30 am
with expected 3-year inflation at 2% or less
Kevin
1. Whose prediction is this?
2. How reliable, in general, have past short to intermediate range (say 2-5 years) predictions of inflation been? I ask that because I don't know, not because I am trying to make a point.
I don't know the answer to the second question.
I think people accept expert predictions too easily without looking into their past track record. Past track record in this case would not be too hard to analyze.
Agree that there is merit to everything you're saying. A few follow-up points.

Breakeven inflation is not "expert predictions", it's just one indicator of what the fixed-income markets are expecting for inflation. Of course you could argue that this is largely based on expectations of institutional fixed-income investors, who one might consider as experts, and that the market bets they are placing on nominal and inflation-indexed Treasuries incorporate their inflation "predictions".

TIPS (or I Bonds) are insurance against the expectations being wrong--i.e., unexpected inflation insurance. Nothing wrong with buying insurance if you feel that the price is right, or if you feel that the consequences of bad outcomes are too severe to take any risk at all of them happening. I just feel that the price of the inflation insurance is too high right now, and at this point am not very worried about the probability + consequence of really bad outcomes. Maybe I should be.

As I said, I accept that a very rational case can be made for using TIPS (or I Bonds to a limited extent) if you don't need to take the risk by using anything else. But even Larry Swedroe and Bill Bernstein have suggested using shorter-term nominal fixed-income as an alternative when TIPS prices are as high as they've been (although Larry has moved on to alternative fixed income funds).

Finally, despite there being no good forecasters, we have to use something for expected values in determining our asset allocations (whether we realize it or not, and whether these expectations are very fuzzy, like stocks have higher expected returns than bonds, or something a bit more precise). We just have to be aware that there is a dispersion of probable outcomes around our estimated expected values, and that our estimated expected values may themselves be off the mark. Such is the uncertainty of investing.

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Re: I-bond fixed rate = 0.3%

Post by protagonist » Sun May 06, 2018 10:39 am

Kevin M wrote: I just feel that the price of the inflation insurance is too high right now, and at this point am not very worried about the probability + consequence of really bad outcomes. Maybe I should be.

As I said, I accept that a very rational case can be made for using TIPS (or I Bonds to a limited extent) if you don't need to take the risk by using anything else.

Kevin
I agree with everything you said in your post above, Kevin. Yes, the price is too high.

But with I-bonds, the risk is almost non-existent, and the promise of inflation protection is still there. If your main interest in fixed income vehicles is wealth preservation, they perform that function better than anything else. The caveat is the spending limit.

I believe in using stock investments for growth and fixed income investments for preservation. Thus I continue to invest in I-bonds at any premium. I shun TIPS because of what you stated above....and I shun long-term TIPS because at 65 it makes no sense to tie my money up for 30 years in order to get the inflation protection that I invested for in the first place while paying taxes on them in the interim.

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Re: I-bond fixed rate = 0.3%

Post by smectym » Sun May 06, 2018 11:41 am

We have over 100 different savings bonds purchased over about 20 years...now they’ve pulled the plug on SBW! I know Treasury has promised a magically seamless export of SBW values to their “Savings Bond Calculator” but as of today Sunday 5/6, the links to those pages are down. I’m sure it’ll happen eventually. Too bad, sort of enjoyed the ritual of updating the ”Wizard” semi-annually

Smectym

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Re: I-bond fixed rate = 0.3%

Post by jeffyscott » Sun May 06, 2018 12:10 pm

protagonist wrote:
Sun May 06, 2018 10:39 am
Kevin M wrote: I just feel that the price of the inflation insurance is too high right now, and at this point am not very worried about the probability + consequence of really bad outcomes. Maybe I should be.

As I said, I accept that a very rational case can be made for using TIPS (or I Bonds to a limited extent) if you don't need to take the risk by using anything else.

Kevin
I agree with everything you said in your post above, Kevin. Yes, the price is too high.

But with I-bonds, the risk is almost non-existent, and the promise of inflation protection is still there. If your main interest in fixed income vehicles is guaranteed wealth preservation, they perform that function better than anything else. The caveat is the spending limit.
I am not sure how the proposed alternative of brokered CDs function, but assuming there are no additional costs and 2.9% is available, then break-even inflation vs. I-bonds would be 2.6%. If I add in the effect of my 7.5% marginal state tax rate, then it's more like 2.4%. With the brokered CDs in tax advantaged space, the break-even point would be somewhere between those, as they would displace something else and eventually be taxed.

If I use the St. Louis Fed expected inflation figure of 2.23%, the "insurance cost" is about 0.27% +/- 0.1%. For our personal situation, high inflation is probably our biggest risk as pension is not indexed to CPI. Apparently, I'll be paying $27 per year for this allotment of inflation insurance via $10K in I-bonds to be purchased this month.

I-bonds do have the added advantage of not displacing anything else from tax-advantaged accounts. We have essentially all assets invested in tax advantaged accounts and I-bonds, except about 1.5% of assets in a few savings and checking accounts. I'm working on reducing that 1.5% by getting rid of the savings accounts in favor of I-bonds.
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Re: I-bond fixed rate = 0.3%

Post by cherijoh » Sun May 06, 2018 12:19 pm

Carl53 wrote:
Tue May 01, 2018 5:33 pm
According to Bloomberg, 5 year TIPS have a yield of 0.72%. Why would I sign up for Ibonds at 0.3%. If I intend to hold longer, 30 year TIPS yield 0.94%. 5 year TIPS look pretty good to me, perhaps better than a 3% CD.
Tips are great for a tax-advantaged account, but not so much in taxable. From this article:
TIPS are treated as other Treasuries in a taxable account with one unpleasant feature: all inflation adjustments to principal are treated as current interest. Taxes are due every year. There are no deferrals.

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Re: I-bond fixed rate = 0.3%

Post by cherijoh » Sun May 06, 2018 12:34 pm

protagonist wrote:
Sun May 06, 2018 10:39 am
Kevin M wrote: I just feel that the price of the inflation insurance is too high right now, and at this point am not very worried about the probability + consequence of really bad outcomes. Maybe I should be.

As I said, I accept that a very rational case can be made for using TIPS (or I Bonds to a limited extent) if you don't need to take the risk by using anything else.

Kevin
I agree with everything you said in your post above, Kevin. Yes, the price is too high.

But with I-bonds, the risk is almost non-existent, and the promise of inflation protection is still there. If your main interest in fixed income vehicles is wealth preservation, they perform that function better than anything else. The caveat is the spending limit.

I believe in using stock investments for growth and fixed income investments for preservation. Thus I continue to invest in I-bonds at any premium. I shun TIPS because of what you stated above....and I shun long-term TIPS because at 65 it makes no sense to tie my money up for 30 years in order to get the inflation protection that I invested for in the first place while paying taxes on them in the interim.
I think everybody needs to evaluate what is "too expensive" based on their own circumstances. Someone early in their career who is paying off a low-interest, 30-yr fixed-rate mortgage probably has all the inflation protection they need and i-Bonds could easily be judged "too expensive". But someone who is nearing retirement, with a non-COLA pension and/or a conservative allocation with bonds in taxable might consider i-Bonds prudent and well worth the insurance premium.

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Re: I-bond fixed rate = 0.3%

Post by Kevin M » Sun May 06, 2018 2:33 pm

jeffyscott wrote:
Sun May 06, 2018 12:10 pm
I am not sure how the proposed alternative of brokered CDs function, but assuming there are no additional costs and 2.9% is available, then break-even inflation vs. I-bonds would be 2.6%.
I just got a smidge over 3% net on a secondary 3-year CD on Friday. There is a commission of $1/$1000 face value for secondary market, but that is factored into the net yield. There is no cost for the new-issue 3-year CD at 2.9%, but 3% after commission is better than 2.9% with no commission. So let's call breakeven relative to I Bonds 2.7%.

However, if I'm looking at a 3-year holding period, I'd probably favor TIPS over I Bonds, as my estimate of the 3-year TIPS expected return is about 0.6% if held to maturity, so that's 30 basis points annualized higher than TIPS, or we could say that it's about twice the expected real return of an I Bond. So to be fair, BEI of the CD at 3% is more like 2.4%.

To argue with myself a bit, you only earn 15 bps per year of extra yield for extending maturity to three years with the TIPS from about one year with the I Bond (you can't sell the I Bond for one year, and then pay the 3-month penalty if you sell before five years). That's OK, but it isn't particularly steep, so maybe I would first go with annual allotment of I Bonds, then use TIPS for more meaningful portfolio inflation protection.

And this leads to a final point, that what I'm doing with CDs is not really a "proposed alternative", since I couldn't do with I Bonds what I'm doing with CDs. The annual purchase limits and use only with taxable-account proceeds preclude it. I could take a very small portion of the taxable cash I have been (and will be doing more) investing in AA/AA munis and to a lesser extent nominal Treasuries, and put that into I Bonds. Maybe I'll do that--it's not either or.
If I add in the effect of my 7.5% marginal state tax rate, then it's more like 2.4%. With the brokered CDs in tax advantaged space, the break-even point would be somewhere between those, as they would displace something else and eventually be taxed.
I am generally buying CDs in tax-advantaged, not taxable, so the state tax exemption doesn't come into play. In taxable I would compare to nominal Treasuries (same state tax exemption) or AAA/AA munis, and I would look at taxable-equivalent yields (TEYs). For me, TEY of a 3-year Treasury at 2.63% is about 2.95% (after state tax exemption factored in), but I probably would beat that with an AA or maybe even AAA muni (historical 3-year default rate for AA is 0.00%). In mid-April I bought a 21-month AA muni at 3.1% TEY.

Not sure how "displacing something else" factors into the yield calculations. For me they wouldn't displace something else, because I would be using proceeds from maturing 5-year direct CDs, transferred from bank or CU into Fidelity. So I would be deploying this cash into TIPS instead of CDs (and threads like this motivate me to look more closely at adding some TIPS into the mix). But of course for you it is different.

I don't think of my traditional IRA as "eventually being taxed", but as split into my share and the government's share based on whatever tax rate I end up paying on distributions, so my share is tax free. Or if it's easier to think about it, just consider that it's in a Roth IRA (if you properly account for taxes, traditional and Roth are essentially equivalent). My most recently matured CD was indeed a Roth IRA CD at PenFed, and the proceeds are now in my Fidelity Roth IRA, being deployed into CDs at this point.
If I use the St. Louis Fed expected inflation figure of 2.23%, the "insurance cost" is about 0.27% +/- 0.1%.

I prefer to use market-based BEI rather than "expert" forecasts, and for any of these we have to look at the time period for the forecast. Is it one year, five years, 10 years? If I'm buying a 3-year CD, I'm interested in the market's expectation of inflation over next three years, and will use that as the expected value, knowing that there's a dispersion of probabilities around this expected value.

At any rate, with 3-year real yield at about 0.6% and 3-year Treasury at about 2.6%, expected 3-year inflation is about 2% (maybe closer to 2.1% if I use more precise values for 3-year TIPS and Treasury). So a 3-year Treasury in IRA or 3-year AA muni in taxable at 3% TEY gives me about 90 basis points of inflation protection relative to market expectations. This is about 30 bps better than using Treasuries in an IRA (or for institutional investors where the state tax exemption probably isn't a factor, and who are setting the prices), so I'm essentially getting 30 bps of unexpected-inflation protection with the securities I'm buying.
For our personal situation, high inflation is probably our biggest risk as pension is not indexed to CPI. Apparently, I'll be paying $27 per year for this allotment of inflation insurance via $10K in I-bonds to be purchased this month.
Yeah, when you look at dollar values for small amounts and low yields, you can almost always make an argument to make whatever point you want, like 2% isn't much better than 1% if you're investing $1,000 (or even $10,000). I've seen a similar point made multiple times just in the last week or two. Same argument can be made for expense ratios, yet most Bogleheads seem to be pretty adamant about keeping ERs as low as possible.

But sure, you're certainly are not taking much risk with $10K in I Bonds, but neither are you adding much inflation protection for anything other than a small portfolio. No harm, no foul (or perhaps, not much benefit, no home run).
I-bonds do have the added advantage of not displacing anything else from tax-advantaged accounts. We have essentially all assets invested in tax advantaged accounts and I-bonds, except about 1.5% of assets in a few savings and checking accounts. I'm working on reducing that 1.5% by getting rid of the savings accounts in favor of I-bonds.
Fair enough.

But what would you displace from tax-advantaged accounts? If inflation is your main concern, then I assume you are holding mostly if not all TIPS or TIPS funds in your tax-advantaged accounts in preference to nominal bonds or bond funds. Correct? If not, then displacing a nominal bond or bond fund with TIPS seems like it would make sense for you. Again, no reason not to do both--buy I Bonds for low term-risk, low real return, and TIPS for more term risk and higher real return. As I mentioned earlier, from a liability-matching perspective, I Bonds only make sense for liabilities up to a year or two, so once past accumulation mode, they would be the first to be used, and pretty soon you'd end up owning only TIPS (unless you've been accumulating I Bonds for many years, in which case you also would have done better by buying longer-maturity TIPS, possibly even in a taxable account).

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Re: I-bond fixed rate = 0.3%

Post by jeffyscott » Sun May 06, 2018 5:13 pm

Kevin M wrote:
Sun May 06, 2018 2:33 pm
To argue with myself a bit, you only earn 15 bps per year of extra yield for extending maturity to three years with the TIPS from about one year with the I Bond (you can't sell the I Bond for one year, and then pay the 3-month penalty if you sell before five years). That's OK, but it isn't particularly steep, so maybe I would first go with annual allotment of I Bonds, then use TIPS for more meaningful portfolio inflation protection.
We've got a few stockpiled, all are over 5 years old, so that stockpile is now like a savings account. Unless we decide to buy a new car or something, what'll probably happen is at least some of those older I-bonds will be cashed in to pay taxes on Roth conversions.
Not sure how "displacing something else" factors into the yield calculations.
I just meant that since I-bonds are tax-deferred. If you forgo them, then something else has to be in a taxable account.
when you look at dollar values for small amounts and low yields, you can almost always make an argument to make whatever point you want, like 2% isn't much better than 1% if you're investing $1,000 (or even $10,000).
I didn't actually mean the $27 that way, I was just stating the figure that my estimate gave. I don't know if it is worth that cost or not :?: , I actually almost posted it as a cost of $270 per year per $100K.
what would you displace from tax-advantaged accounts?
That I don't know. After looking at the wiki here on that, it might be a major advantage of the I-bonds that I don't have to analyze that issue :D :wink: . We actually have no TIPS, I sold the last of the fund when 10 year went below 1%, figuring I'd start buying back when it went above 1.5%...it's been a long wait. I'll probably keep waiting for that before extending maturity, but probably going to start doing some of the waiting in VTAPX (replacing a stable value fund, via partial rollover).
As I mentioned earlier, from a liability-matching perspective, I Bonds only make sense for liabilities up to a year or two...
And during the discussion here, I actually realized that is what will likely be the case for us, as we'll soon use them to pay taxes if nothing else.
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