Just how good is I-bonds' nominal guarantee during deflation?

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Day9
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Just how good is I-bonds' nominal guarantee during deflation?

Post by Day9 » Sun Dec 16, 2018 11:20 pm

From the bogleheads wiki: "if the real interest rate goes up, I-Bonds can be redeemed at accrued value anytime after you've held them for at least 12 months (you'd lose the last three months' interest if redeemed prior to five years), while TIPS go down in value. Advantage: I-Bonds." (link)

How good is this advantage of I-bonds? Is it a negligible case that will almost never occur, and even if it does it will hardly make any difference? Or does this make I-bonds the supreme investment, protecting against both inflation and deflation, while investors lament the paltry $10k/year/SSN limit?

(EDIT 12/22) The Bogleheads wiki also says this:

The fixed rate component of both TIPS and I-Bonds is based on real interest rates, which are normally positive. Real interest rates can sometimes go negative, however. When real interest rates are negative, the fixed rate on TIPS is also negative.

However, the fixed rate component of the I-Bond has a floor at 0% and cannot go negative. This is a large advantage of I-Bonds when purchasing during a period of negative real interest rates. You can view current levels of real interest rates here. Advantage: I-Bonds (link)
Last edited by Day9 on Sat Dec 22, 2018 8:22 pm, edited 1 time in total.
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by asif408 » Mon Dec 17, 2018 8:16 am

Depends on when the TIPS matures. If you have to sell it before it matures, yes, that statement is true. But if you don't have to sell the TIPS before it matures you can't get back less than par. So while it may fall in value you can't lose what you initially invested if waiting until maturity. Of course, with the I-bond it never decreases in value. So the I-bond is more flexible from that perspective, and the degree of its advantage depends on the time frame.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by telemark » Mon Dec 17, 2018 10:49 pm

Deflation and interest rate increases are two separate things, but they have both happened recently. In 2015 we had very mild deflation. During that time the inflation adjustment for I bonds went to zero, but their real (after deflation) rate was somewhat higher. Any investment that holds its nominal value is a win during deflation. More recently, interest rates have gone up, with the rest of the bond market going down accordingly, but without affecting savings bonds.

On the other hand, other types of bonds will increase in value when interest rates go down, but not savings bonds.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by MisterMister » Mon Dec 17, 2018 11:27 pm

Day9 wrote:
Sun Dec 16, 2018 11:20 pm
...while investors lament the paltry $10k/year/SSN limit? (for I-Bonds)
10K + your federal tax refund (your refund can be in I-Bonds).

They're currently yielding 2.83%. Right now that's a little more than a one-year CD, but unlike a CD the interest is not taxable at the state level. Not such a bad deal and the 3-month EWP (after one year) is not awful.

I have a few (just a few, unfortunately) that were bought in 2001 that are yielding 5.66% now because the fixed portion of the interest was higher then. If I'm still in my state when I cash in that will be roughly the taxable equivalent of 6%. Right now I'd be thrilled if my whole portfolio was in those 5.66% I-Bonds!

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Tue Dec 18, 2018 12:46 pm

Actually, the higher the rate of DEflation, the higher the REAL rate of return on the I Bonds. So the I Bonds are the REAL (pun intended) winner. The longer the deflationary period, the more you'll wish you owneI Bonds.

So, I Bonds offer both inflation AND deflation protection
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by #Cruncher » Tue Dec 18, 2018 1:34 pm

telemark wrote:
Mon Dec 17, 2018 10:49 pm
Deflation and interest rate increases are two separate things, ...
Good point, telemark!. The original poster seems to be confusing these two events.

telemark, continuing in same post, wrote:In 2015 we had very mild deflation. During that time the inflation adjustment for I bonds went to zero, but their real (after deflation) rate was somewhat higher.
Actually the I Bond semi-annual inflation rate announced 5/1/2015 was negative at -0.80%. Following the regular procedure this was combined with the fixed rates of all I Bonds to produce their composite rates for the next six months. Because the composite rate can't be less than 0%, the real composite rate was greater than the fixed rate for some I Bonds. As shown in the following table (modified from my May 2015 post), these were the ones with a fixed rate of 1.60% or less. I Bonds with a 0% fixed rate benefitted the most. However, I Bonds with a fixed rate more than 1.60% did not benefit at all; their real composite rate was the same as their fixed rate.

Code: Select all

                      Real
Fixed  Composite  Composite  Benefit of
 Rate       Rate       Rate    0% Floor

Code: Select all

3.60%      1.97%      3.60%      
3.40%      1.77%      3.40%      
3.30%      1.67%      3.30%      
3.00%      1.38%      3.00%      
2.00%      0.38%      2.00%      
1.60%      0.00%      1.61%      +0.01%
1.40%      0.00%      1.61%      +0.21%
1.30%      0.00%      1.61%      +0.31%
1.20%      0.00%      1.61%      +0.41%
1.10%      0.00%      1.61%      +0.51%
1.00%      0.00%      1.61%      +0.61%
0.70%      0.00%      1.61%      +0.91%
0.30%      0.00%      1.61%      +1.31%
0.20%      0.00%      1.61%      +1.41%
0.10%      0.00%      1.61%      +1.51%
0.00%      0.00%      1.61%      +1.61%

Mel Lindauer wrote:
Tue Dec 18, 2018 12:46 pm
So, I Bonds offer both inflation AND deflation protection
With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
Last edited by #Cruncher on Tue Dec 18, 2018 2:03 pm, edited 1 time in total.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by nisiprius » Tue Dec 18, 2018 1:42 pm

#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
...With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
Yes, my thoughts exactly. Whenever people talk about "deflation protection" I'm just baffled. I don't get it. I think this is meaningless competitive investing: "I want my investments to outperform all the time, whether I need it or not."
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by telemark » Tue Dec 18, 2018 2:42 pm

#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
telemark, continuing in same post, wrote:In 2015 we had very mild deflation. During that time the inflation adjustment for I bonds went to zero, but their real (after deflation) rate was somewhat higher.
Actually the I Bond semi-annual inflation rate announced 5/1/2015 was negative at -0.80%. Following the regular procedure this was combined with the fixed rates of all I Bonds to produce their composite rates for the next six months. Because the composite rate can't be less than 0%, the real composite rate was greater than the fixed rate for some I Bonds. As shown in the following table (modified from my May 2015 post), these were the ones with a fixed rate of 1.60% or less. I Bonds with a 0% fixed rate benefitted the most. However, I Bonds with a fixed rate more than 1.60% did not benefit at all; their real composite rate was the same as their fixed rate.
I was confused about that. Thanks for the explanation.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Tue Dec 18, 2018 3:43 pm

#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
telemark wrote:
Mon Dec 17, 2018 10:49 pm
Deflation and interest rate increases are two separate things, ...
Good point, telemark!. The original poster seems to be confusing these two events.

telemark, continuing in same post, wrote:In 2015 we had very mild deflation. During that time the inflation adjustment for I bonds went to zero, but their real (after deflation) rate was somewhat higher.
Actually the I Bond semi-annual inflation rate announced 5/1/2015 was negative at -0.80%. Following the regular procedure this was combined with the fixed rates of all I Bonds to produce their composite rates for the next six months. Because the composite rate can't be less than 0%, the real composite rate was greater than the fixed rate for some I Bonds. As shown in the following table (modified from my May 2015 post), these were the ones with a fixed rate of 1.60% or less. I Bonds with a 0% fixed rate benefitted the most. However, I Bonds with a fixed rate more than 1.60% did not benefit at all; their real composite rate was the same as their fixed rate.

Code: Select all

                      Real
Fixed  Composite  Composite  Benefit of
 Rate       Rate       Rate    0% Floor

Code: Select all

3.60%      1.97%      3.60%      
3.40%      1.77%      3.40%      
3.30%      1.67%      3.30%      
3.00%      1.38%      3.00%      
2.00%      0.38%      2.00%      
1.60%      0.00%      1.61%      +0.01%
1.40%      0.00%      1.61%      +0.21%
1.30%      0.00%      1.61%      +0.31%
1.20%      0.00%      1.61%      +0.41%
1.10%      0.00%      1.61%      +0.51%
1.00%      0.00%      1.61%      +0.61%
0.70%      0.00%      1.61%      +0.91%
0.30%      0.00%      1.61%      +1.31%
0.20%      0.00%      1.61%      +1.41%
0.10%      0.00%      1.61%      +1.51%
0.00%      0.00%      1.61%      +1.61%

Mel Lindauer wrote:
Tue Dec 18, 2018 12:46 pm
So, I Bonds offer both inflation AND deflation protection
With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
The deflation protection is against the loss of previous gains/earnings.
Best Regards - Mel | | Semper Fi

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Phineas J. Whoopee » Tue Dec 18, 2018 7:37 pm

#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
... With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
Hi #Cruncher.

Your dollars will buy more, each, but you need especially enormous protection against deflation, because of the other things it does.

Let's imagine you, as many people here advocate, were a landlord, owning several buildings, and provided laundry facilities, and the washing machines were wearing out and were on the edge of needing so much maintenance that over the mid-term it might be more sensible to replace them. I'm casting you not as you personally. Maybe I should say "one," but "you" it is.

If there's deflation, such that you predict a year from now you can buy new washing machines less expensively than today, would it make sense to replace them, or to fix them for now and wait a year?

Precisely.

The problem is everybody else also knows that. The repair people get a bump in business, but the manufacturers, wholesalers, sellers, delivery people, and installers all lose business. That means they have very little money, so they spend less.

That means the grocer gets little money as people switch from champagne and caviar to beer and peanuts. That means the grocer has to cut back on staff.

That means whatever businesses you're in or invested in have less traffic.

That means your tenants can't pay their rent.

Having some secure money in such a situation might be the difference between rice and beans, and the soup line. I Bonds fill the role nicely whichever direction inflation goes.

That's why.

PJW

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by columbia » Tue Dec 18, 2018 7:41 pm

I-bonds and TIPS seems more likely to make the difference in keeping the lights on, than international magically coming to rescue.

I don’t own either, but I probably should.
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by #Cruncher » Wed Dec 19, 2018 3:20 pm

Mel Lindauer wrote:
Tue Dec 18, 2018 3:43 pm
#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
Mel Lindauer wrote:
Tue Dec 18, 2018 12:46 pm
So, I Bonds offer both inflation AND deflation protection
With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
The deflation protection is against the loss of previous gains/earnings.
That's correct, Mel, if we look at the nominal value of an I Bond. But in real terms there would be no "loss of previous gains/earnings" without the 0% floor on the composite rate. Say I buy a $1,000 0% fixed rate I Bond this month and the semi-annual inflation rate is -1.00%. Withour the floor, the composite rate would be -2.00%, causing the nominal value after 6 months to be $990. But this would have the same $1,000 real value as my purchase; so there would be no loss of value to "protect" against.

Better than calling the benefit of the 0% composite rate floor "deflation protection" would be to call it a "deflation bonus". Continuing my illustration, if the next semi-annual inflation rate is +1.00%, the I Bond's value (both nominal and real) after one year would be $1,010. Without the floor its value (again both nominal and real) would have been only $1,000. So, rather than protecting me against a non-existent real loss, the 0% floor gave me a bonus of $10 in real value.


Phineas J. Whoopee wrote:
Tue Dec 18, 2018 7:37 pm
#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
... With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
… Your dollars will buy more, each, but you need especially enormous protection against deflation, because of the other things it does.
By "other things it does" I assume you mean things like economic depressions or recessions, PJW. But It's debatable whether deflation does (i.e., causes) depressions or recessions. For example there are cases like the last 30 years of the 19th century that experienced good economic growth despite a falling price level.

So I would say that I Bonds (and all high-quality debt securities and cash) do "protect" (or at least mitigate) against depressions and recessions, but that there is nothing about deflation per se to protect or mitigate against.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Wed Dec 19, 2018 5:27 pm

#Cruncher wrote:
Wed Dec 19, 2018 3:20 pm
Mel Lindauer wrote:
Tue Dec 18, 2018 3:43 pm
#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
Mel Lindauer wrote:
Tue Dec 18, 2018 12:46 pm
So, I Bonds offer both inflation AND deflation protection
With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
The deflation protection is against the loss of previous gains/earnings.
That's correct, Mel, if we look at the nominal value of an I Bond. But in real terms there would be no "loss of previous gains/earnings" without the 0% floor on the composite rate. Say I buy a $1,000 0% fixed rate I Bond this month and the semi-annual inflation rate is -1.00%. Withour the floor, the composite rate would be -2.00%, causing the nominal value after 6 months to be $990. But this would have the same $1,000 real value as my purchase; so there would be no loss of value to "protect" against.

Better than calling the benefit of the 0% composite rate floor "deflation protection" would be to call it a "deflation bonus". Continuing my illustration, if the next semi-annual inflation rate is +1.00%, the I Bond's value (both nominal and real) after one year would be $1,010. Without the floor its value (again both nominal and real) would have been only $1,000. So, rather than protecting me against a non-existent real loss, the 0% floor gave me a bonus of $10 in real value.


Phineas J. Whoopee wrote:
Tue Dec 18, 2018 7:37 pm
#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
... With deflation, the purchasing power of my dollars increases. I've never understood why I need protection against that!
… Your dollars will buy more, each, but you need especially enormous protection against deflation, because of the other things it does.
By "other things it does" I assume you mean things like economic depressions or recessions, PJW. But It's debatable whether deflation does (i.e., causes) depressions or recessions. For example there are cases like the last 30 years of the 19th century that experienced good economic growth despite a falling price level.

So I would say that I Bonds (and all high-quality debt securities and cash) do "protect" (or at least mitigate) against depressions and recessions, but that there is nothing about deflation per se to protect or mitigate against.
I like your term "deflation bonus" better and will be using it in the future if it's not copyrighted, #Cruncher. :D
Best Regards - Mel | | Semper Fi

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by #Cruncher » Thu Dec 20, 2018 10:48 am

Mel Lindauer wrote:
Wed Dec 19, 2018 5:27 pm
I like your term "deflation bonus" better and will be using it in the future if it's not copyrighted, #Cruncher. :D
Thanks for the compliment, Mel. :happy You're welcome to use the term "deflation bonus". The thought that someone might copyright it never occurred to me. As far as I know, no one has.

The term would apply equally to the TIPS guarantee of a minimum 1.0 index ratio applied to the principal at maturity. (See the FAQ, What happens to TIPS if deflation occurs?.) But -- unlike the I Bond guarantee -- I doubt it will ever come into play.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by MisterMister » Thu Dec 20, 2018 11:26 am

Probably like most people posting here, I have a handful of spreadsheets I've developed or found to aid my planning. Some of them have to do with alternative fixed investments, for example when it makes sense to break a CD to buy another.

So I have a firm grasp of TVM calculations and other financial math.

I have a very clear understanding of IBonds and what rate I could expect on a given bond given various inflation scenarios.

TIPS is another matter. I don't understand how TIPS yields are competitive with IBonds (if indeed they are) or why I would choose one vs the other. I've done some Internet research but I've failed to learn much, it seems I'm not alone in my poor understanding of TIPs.

I wonder if anyone might have some pointers or guidelines that would be helpful. Don't mean to hijack the thread but it seems related to posts here.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Thu Dec 20, 2018 11:42 am

MisterMister wrote:
Thu Dec 20, 2018 11:26 am
Probably like most people posting here, I have a handful of spreadsheets I've developed or found to aid my planning. Some of them have to do with alternative fixed investments, for example when it makes sense to break a CD to buy another.

So I have a firm grasp of TVM calculations and other financial math.

I have a very clear understanding of IBonds and what rate I could expect on a given bond given various inflation scenarios.

TIPS is another matter. I don't understand how TIPS yields are competitive with IBonds (if indeed they are) or why I would choose one vs the other. I've done some Internet research but I've failed to learn much, it seems I'm not alone in my poor understanding of TIPs.

I wonder if anyone might have some pointers or guidelines that would be helpful. Don't mean to hijack the thread but it seems related to posts here.
You bring up an important point that most people find difficult to understand. While I Bonds can never lose nominal value during a period of deflation, TIPS can, unless held to maturity. That's what #Cruncher rightly calls the I Bonds' "deflation bonus".
Best Regards - Mel | | Semper Fi

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by MisterMister » Thu Dec 20, 2018 12:09 pm

Thanks, that is a tricky comparison to get straight. But my confusion is even more basic than that.

For example, I believe TIPS are yielding 1.0%. Under what scenario would it be an advantage to choose TIPS over IBonds, which currently yield over 2.8%? Both instruments have inflation protection, but I don't see how TIPs would become the right choice. Here I'm ignoring the 10K limit.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by boglerdude » Fri Dec 21, 2018 2:27 am

Under what macro scenarios will a 5 year TIPS beat a 5 year treasury, given both are priced on inflation expectations.

And how is this not trying to beat the market. Why "overweight" TIPS

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by tindel » Fri Dec 21, 2018 9:40 am

I-bonds are the only investment that I'm aware of that *guarantees* protection from *both* inflation and deflation. The deflation protection simply means that the composite rate cannot go below 0% - i.e. your investment cannot lose value. Meaning that higher fixed rate I-bonds are not as good as lower fixed rate I-bonds in terms of deflation.

Another huge advantage is the ability to cash out anytime between 1-5 years with a small penalty or anytime from 5-30 years. This makes it a particularly good investment for 2nd and 3rd tier emergency funds where both protection from inflation and preservation of capital is important.

I personally consider I-bonds to be part of my overall bond portfolio.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by ThriftyPhD » Fri Dec 21, 2018 9:46 am

boglerdude wrote:
Fri Dec 21, 2018 2:27 am
Under what macro scenarios will a 5 year TIPS beat a 5 year treasury, given both are priced on inflation expectations.

And how is this not trying to beat the market. Why "overweight" TIPS
I believe TIPS will outperform when there is more inflation than expectations. As you said, they're priced based on expected inflation, but since TIPS are inflation protected you'll likely get a bit less return from them under expected inflation conditions. You're paying a bit for the inflation protection. If inflation is higher than expected, the inflation protection kicks in and you'll outperform. If there is no unexpected inflation, the nominal bonds will win because you paid for inflation protection that wasn't needed. If there is less inflation than expected, you'll underperform the nominal bonds even more.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by #Cruncher » Fri Dec 21, 2018 1:10 pm

MisterMister wrote:
Thu Dec 20, 2018 12:09 pm
... I believe TIPS are yielding 1.0%. Under what scenario would it be an advantage to choose TIPS over IBonds, which currently yield over 2.8%? Both instruments have inflation protection, but I don't see how TIPs would become the right choice.
You're comparing "apples and oranges", MisterMister. The 1.0% current yield of many TIPS is a real yield before inflation adjustment. The 2.83% current I Bond composite rate is after inflation adjustment. The proper rate to compare against TIPS yields is the I Bond fixed rate which is currently 0.5%.

An I Bond will have the same return if the I Bond fixed rate equals the TIPS yield. [*] For example, lets compare a $10,000 I Bond with a 1.0% fixed rate against a 5-year TIPS with a 1.0% coupon that is bought at par. Assume for illustration that the CPI increases 1.0% every six months during the entire five years. The I Bond's composite rate will be 3.01% calculated as shown here:
3.01% = 0.01 + 2 * 0.01 + 0.01 * 0.01

After five years with semi-annual compounding the I Bond's value will grow to about $11,611. This is shown in column B below.
11,611 = 10000 * (1 + 0.0301 / 2) ^ 10

Column D of the table below shows the interest and principal payments of the TIPS after adjustment for the CPI shown in column C. When the timing of the cash flow is taken into account, the TIPS has the same 3.01% return as the I Bond -- as calculated with the Excel IRR function:
3.01% = 2 * IRR(D6:D16)

Code: Select all

Row   Col A        Col B       Col C       Col D
     Period       I Bond         CPI   TIPS Cash
  6       0    10,000.00    1.000000  (10,000.00)
  7       1    10,150.50    1.010000       50.50 
  8       2    10,303.27    1.020100       51.01 
  9       3    10,458.33    1.030301       51.52 
 10       4    10,615.73    1.040604       52.03 
 11       5    10,775.49    1.051010       52.55 
 12       6    10,937.66    1.061520       53.08 
 13       7    11,102.28    1.072135       53.61 
 14       8    11,269.37    1.082857       54.14 
 15       9    11,438.97    1.093685       54.68 
 16      10    11,611.13    1.104622   11,101.45
* There are a couple of qualifications:
  • While both I Bonds and TIPS are adjusted to the same CPI-U index, the timing is different. The effect can be significant over short periods, but evens out over longer periods.
  • If any six-month CPI adjustment applied to and I Bond is negative enough that it triggers the "deflation bonus" discussed above, the I Bond will have a higher return than the TIPS.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by MisterMister » Fri Dec 21, 2018 1:13 pm

#Cruncher wrote:
Fri Dec 21, 2018 1:10 pm
MisterMister wrote:
Thu Dec 20, 2018 12:09 pm
... I believe TIPS are yielding 1.0%. Under what scenario would it be an advantage to choose TIPS over IBonds, which currently yield over 2.8%? Both instruments have inflation protection, but I don't see how TIPs would become the right choice.
You're comparing "apples and oranges", MisterMister. The 1.0% current yield of many TIPS is a real yield before inflation adjustment. The 2.83% current I Bond composite rate is after inflation adjustment. The proper rate to compare against TIPS yields is the I Bond fixed rate which is currently 0.5%.

An I Bond will have the same return if the I Bond fixed rate equals the TIPS yield. [*] For example, lets compare a $10,000 I Bond with a 1.0% fixed rate against a 5-year TIPS with a 1.0% coupon that is bought at par. Assume for illustration that the CPI increases 1.0% every six months during the entire five years. The I Bond's composite rate will be 3.01% calculated as shown here:
3.01% = 0.01 + 2 * 0.01 + 0.01 * 0.01

After five years with semi-annual compounding the I Bond's value will grow to about $11,611. This is shown in column B below.
11,611 = 10000 * (1 + 0.0301 / 2) ^ 10

Column D of the table below shows the interest and principal payments of the TIPS after adjustment for the CPI shown in column C. When the timing of the cash flow is taken into account, the TIPS has the same 3.01% return as the I Bond -- as calculated with the Excel IRR function:
3.01% = 2 * IRR(D6:D16)

Code: Select all

Row   Col A        Col B       Col C       Col D
     Period       I Bond         CPI   TIPS Cash
  6       0    10,000.00    1.000000  (10,000.00)
  7       1    10,150.50    1.010000       50.50 
  8       2    10,303.27    1.020100       51.01 
  9       3    10,458.33    1.030301       51.52 
 10       4    10,615.73    1.040604       52.03 
 11       5    10,775.49    1.051010       52.55 
 12       6    10,937.66    1.061520       53.08 
 13       7    11,102.28    1.072135       53.61 
 14       8    11,269.37    1.082857       54.14 
 15       9    11,438.97    1.093685       54.68 
 16      10    11,611.13    1.104622   11,101.45
* There are a couple of qualifications:
  • While both I Bonds and TIPS are adjusted to the same CPI-U index, the timing is different. The effect can be significant over short periods, but evens out over longer periods.
  • If any six-month CPI adjustment applied to and I Bond is negative enough that it triggers the "deflation bonus" discussed above, the I Bond will have a higher return than the TIPS.
I have some study cut out for me now, but this is incredibly helpful. Thank you so much for this.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Fri Dec 21, 2018 1:51 pm

One other difference between Tips held in a taxable account and I Bonds is that the I Bonds are tax-deferred for up to 30 years. That allows for compounding and some possible tax-shifting from higher tax rates in one's working years to a lower tax bracket in 30 years when they may well be retired.
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Fri Dec 21, 2018 1:54 pm

Another difference is that I Bond earnings can be tax-free when used for qualifying educational expenses.
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Fri Dec 21, 2018 8:52 pm

Finally, even though purchased with after-tax dollars in a taxable account, I Bonds offer tax-deferral which means they can help expand an investor's tax-deferred space beyond the normal 401k, IRA, etc. contribution limits.
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by MisterMister » Fri Dec 21, 2018 9:40 pm

Mel Lindauer wrote:
Fri Dec 21, 2018 8:52 pm
Finally, even though purchased with after-tax dollars in a taxable account, I Bonds offer tax-deferral which means they can help expand an investor's tax-deferred space beyond the normal 401k, IRA, etc. contribution limits.
That right and I believe that applies to TIPS as well as iBonds. It can help.

To determine the equivalent taxable rate use this formula:

rate x (1-FT) / (1-FT-SLT)

where
rate = yield on the bond
FT = federal income tax rate (e.g. .22 for 22% bracket)
SLT = state & local income tax (e.g. .05499 for North Carolina; NC has the highest flat rate tax, @ 5.499%)

So in NC an I Bond yielding 2.8% would the equivalent of a 3.01% taxable CD for someone in the 22% bracket.

Simple calculation but maybe someone may find it useful.
Last edited by MisterMister on Sat Dec 22, 2018 2:10 pm, edited 1 time in total.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by FactualFran » Sat Dec 22, 2018 1:51 pm

#Cruncher wrote:
Tue Dec 18, 2018 1:34 pm
Actually the I Bond semi-annual inflation rate announced 5/1/2015 was negative at -0.80%.
A worse case was the -2.78% semi-annual inflation rate announced 5/1/2009. The composite rate of all I-Bonds that used that inflation adjustment was zero.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by tfb » Sat Dec 22, 2018 2:08 pm

Back to the original question -- "just how good?" -- given that deflation doesn't happen often, the deflation bonus from I Bonds only kicks in briefly, and it's very small in size. It's something, but insignificant relative to the difference in the fixed rate when compared to TIPS. When TIPS real yields were negative and I Bonds fixed rate was zero, I Bonds were very good. Now the fixed rate lags TIPS yield again. They aren't as good as they once were.
Harry Sit, taking a break from the forums.

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Day9 » Sat Dec 22, 2018 8:23 pm

Thanks everyone. I updated the original post with another relevant section from the Bogleheads wiki. I would be thankful if someone could answer my original question: Just how good of a benefit is this? Is this a negligible benefit that will rarely happen and even when it does, provide a negligible benefit? Or does this make Ibonds the ultimate investment? I'm guessing somewhere in between and I would be thankful to anyone who could provide a good analysis for exactly how strong this benefit is.
I'm just a fan of the person I got my user name from

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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by Mel Lindauer » Sun Dec 23, 2018 11:58 am

MisterMister wrote:
Fri Dec 21, 2018 9:40 pm
Mel Lindauer wrote:
Fri Dec 21, 2018 8:52 pm
Finally, even though purchased with after-tax dollars in a taxable account, I Bonds offer tax-deferral which means they can help expand an investor's tax-deferred space beyond the normal 401k, IRA, etc. contribution limits.
That right and I believe that applies to TIPS . . .
Not true. You'll pay taxes annually when you hold TIPS in your taxable account. Here's more on that:

TIPS are taxed in a slightly different manner than conventional Treasury bonds. The periodic inflation- based “gross-up” in the principal of TIPS is taxed at the ordinary income tax rate, rather than at the lower capital gains rate. These taxes are payable every tax year regardless of the investor's holding period.


So you're paying taxes on income you don't actually receive until redemption. I call this "phantom income".
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Re: Just how good is I-bonds' nominal guarantee during deflation?

Post by #Cruncher » Thu Apr 16, 2020 1:16 pm

tfb wrote:
Sat Dec 22, 2018 2:08 pm
Back to the original question -- "just how good?" -- given that deflation doesn't happen often, the deflation bonus from I Bonds only kicks in briefly, and it's very small in size.
I'm reopening this old thread because, with the terrible state of the economy, there's more chance of deflation over one of the 6 month periods used to index I Bonds' composite rate. First, here is an update of the benefit the 0% composite rate floor [1] has had on I Bonds issued from November 1998 to May 2015. This is an update of my post, Re: I-bonds look pretty bad right now in another thread.

Code: Select all

        Fixed     CPI            Grows  End Value   Extra
Bought   Rate   Month      CPI      To  w/o Floor  Return

Code: Select all

Nov 98  3.30%  Mar 98  162.200  324.16     319.96   0.06%
May 99  3.30%  Sep 98  163.600  316.04     312.07   0.06%
Nov 99  3.40%  Mar 99  165.000  314.12     310.60   0.05%
May 00  3.60%  Sep 99  167.900  315.52     312.17   0.05%
Nov 00  3.40%  Mar 00  171.200  292.96     289.43   0.06%
May 01  3.00%  Sep 00  173.700  263.76     260.28   0.07%
Nov 01  2.00%  Mar 01  176.200  214.48     210.58   0.10%
May 02  2.00%  Sep 01  178.300  209.84     206.04   0.10%
Nov 02  1.60%  Mar 02  178.800  193.72     189.79   0.12%
May 03  1.10%  Sep 02  181.000  175.52     170.94   0.16%
Nov 03  1.10%  Mar 03  184.200  171.32     167.05   0.15%
May 04  1.00%  Sep 03  185.200  167.16     162.63   0.17%
Nov 04  1.00%  Mar 04  187.400  164.16     159.92   0.17%
May 05  1.20%  Sep 04  189.900  165.84     161.79   0.17%
Nov 05  1.00%  Mar 05  193.300  157.64     153.50   0.18%
May 06  1.40%  Sep 05  198.800  160.48     157.01   0.16%
Nov 06  1.40%  Mar 06  199.800  158.84     155.14   0.17%
May 07  1.30%  Sep 06  202.900  153.28     149.76   0.18%
Nov 07  1.20%  Mar 07  205.352  148.80     145.20   0.20%
May 08  0.00%  Sep 07  208.490  127.80     123.15   0.31%
Nov 08  0.70%  Mar 08  213.528  134.20     130.31   0.26%
May 09  0.10%  Sep 08  218.783  123.00     118.66   0.33% <==
Nov 09  0.30%  Mar 09 [212.709] 125.32     124.57   0.06% CPI down 2.78%
May 10  0.20%  Sep 09  215.969  122.20     121.29   0.07%
Nov 10  0.00%  Mar 10  217.631  118.96     117.98   0.09%
May 11  0.00%  Sep 10  218.439  118.56     117.54   0.10%
Nov 11  0.00%  Mar 11  223.467  115.88     114.90   0.10%
May 12  0.00%  Sep 11  226.889  114.12     113.17   0.11%
Nov 12  0.00%  Mar 12  229.392  112.80     111.93   0.10%
May 13  0.00%  Sep 12  231.407  111.92     110.96   0.12%
Nov 13  0.20%  Mar 13  232.773  112.52     111.75   0.11%
May 14  0.10%  Sep 13  234.149  111.16     110.32   0.13%
Nov 14  0.00%  Mar 14  236.293  109.52     108.66   0.14%
May 15  0.00%  Sep 14  238.031  108.76     107.87   0.16%
               Mar 15 [236.119]                           CPI down 0.80%
The greatest benefit occurred with a 0.10% Fixed Rate I Bond Purchased May 2009. A $100 purchase will grow to $123.00 in May 2020 [2]. But without the 0% floor feature, it would have grown to only $118.66. [3] The means the floor feature has increased the annual return 0.33% points over t1 years.
0.33% = 2 * ((123.00 / 118.66) ^ (1 / 22) - 1)

But what about the future? I've developed a little spreadsheet to calculate what effect a future deflationary six month period would have on an I Bond's real return. For example it shows that, assuming an average CPI increase of 1% each six months over five years, a single period with a decrease of -1.0% would raise the real return of a 0.2% fixed rate I Bond to 0.38%.

Code: Select all

Row                 Col A     Col B     Col C     Col D     Col E     Col F     Col G
  1                Amount       100
  2                 Years         5
  3            Fixed rate     0.20%
  4  Real value w/o floor   101.005
  5    Avg 6 mo inflation     1.00%
  6              One time Remaining  One Time Remaining   Nominal      Real Annl Real
  7        6 Mo Inflation 6MoInflat Comp Rate Comp Rate End Value End Value    Return

Code: Select all

  8                 2.0%    0.8895%   4.2040%   1.9808%   111.572   101.005     0.20%
  9                 1.0%    1.0000%   2.2020%   2.2020%   111.572   101.005     0.20%
 10                 0.0%    1.1117%   0.2000%   2.4257%   111.572   101.005     0.20%
 11                (1.0%)   1.2247%   0.0000%   2.6519%   112.586   101.923     0.38% <== [4]
 12                (2.0%)   1.3390%   0.0000%   2.8806%   113.735   102.963     0.58%
 13                (3.0%)   1.4545%   0.0000%   3.1119%   114.908   104.024     0.79%
 14                (4.0%)   1.5714%   0.0000%   3.3459%   116.105   105.108     1.00%
 15                (5.0%)   1.6896%   0.0000%   3.5826%   117.327   106.214     1.21%
To use the spreadsheet with other assumptions follow these steps:
  • Select All, Copy, and Paste [5] the following at cell A1 of a blank Excel sheet:

    Code: Select all

    Amount	100
    Years	5
    Fixed rate	0.002
    Real value w/o floor	=B1*(1+B3/2)^(B2*2)
    Avg 6 mo inflation	0.01
    One time	Remaining	One Time	Remaining	Nominal	Real	Annl Real
    6 Mo Inflation	6MoInflat	Comp Rate	Comp Rate	End Value	End Value	Return
    0.02	=((1+B$5)^(B$2*2)/(1+A8))^(1/(B$2*2-1))-1	=MAX(0,$B$3+2*A8+$B$3*A8)	=MAX(0,$B$3+2*B8+$B$3*B8)	=B$1*(1+C8/2)*(1+D8/2)^(B$2*2-1)	=E8/(1+B$5)^(B$2*2)	=2*((F8/B$1)^(1/(B$2*2))-1)
    0.01	=((1+B$5)^(B$2*2)/(1+A9))^(1/(B$2*2-1))-1	=MAX(0,$B$3+2*A9+$B$3*A9)	=MAX(0,$B$3+2*B9+$B$3*B9)	=B$1*(1+C9/2)*(1+D9/2)^(B$2*2-1)	=E9/(1+B$5)^(B$2*2)	=2*((F9/B$1)^(1/(B$2*2))-1)
    =2*A9-A8	=((1+B$5)^(B$2*2)/(1+A10))^(1/(B$2*2-1))-1	=MAX(0,$B$3+2*A10+$B$3*A10)	=MAX(0,$B$3+2*B10+$B$3*B10)	=B$1*(1+C10/2)*(1+D10/2)^(B$2*2-1)	=E10/(1+B$5)^(B$2*2)	=2*((F10/B$1)^(1/(B$2*2))-1)
  • Format for readability.
  • Copy row 10 down to row 15.
  • Revise as needed the assumptions in cells B1:B3, B5, and A8:A15. (In most cases, the assumption for "Avg 6 mo inflation" in cell B5, does not affect the values for "Annl Real Return" in column G.)
  1. From Combining the two rates on TreasuryDirect:
    To get the actual rate of interest (sometimes referred to as the composite or earnings rate) we combine the fixed rate and the inflation rate, using the equation in the example below.
    • The combined rate will never be less than zero. However, the combined rate can be lower than the fixed rate. If the inflation rate is negative (because we have deflation, not inflation), it can offset some of the fixed rate.
    • If the inflation rate is so negative that it would take away more than the fixed rate, we don't let that happen. We stop at zero.
    (underlines added)
  2. The "Grows To" column of the table computed by the macro in my I Bond Portfolio Calculator spreadsheet.
  3. 118.66 = 100 * (1 + 0.001 / 2) ^ (11 * 2) * (256.759 / 218.783) where 256.759 is the CPI for September 2019. (For CPI choose U.S. city average, All items - CUUR0000SA0 from the BLS Top Picks.)
  4. Calculation of 0.38% real return:

    Code: Select all

    1.2247% = (1.01 ^ 10 / 0.99) ^ (1 / 9) - 1
    2.6519% = 0.002 + 2 * 0.012247 + 0.002 * 0.012247
    112.586 = 100 * (1 + 0.026519 / 2) ^ 9
    101.923 = 112.586 / 1.01 ^ 10
      0.38% = 2 * ((101.923 / 100) ^ (1 / 10) - 1)
  5. If you have trouble pasting, try "Paste Special" and "Text".

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