Hidden liquidity risk with I-bonds

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Northern Flicker
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Hidden liquidity risk with I-bonds

Post by Northern Flicker » Mon Oct 21, 2019 10:41 pm

The description of I-bonds will present two liquidity constraints— you cannot liquidate then at all for the first 12 months of holding them, and there is a penalty of a 3-month’s interest for liquidation in the first 5 years.

But there also is a more subtle, hidden liquidity risk. Consider what happens to a bond when interest rates rise and fall. If you hold a TIPS and real rates rise, the market value of the TIPS falls. By comparison, an I-bond (over 5 years old) may be cashed in at par, a benefit for the I-bond.

But now look at what happens when real rates fall. The price of the TIPS goes up. If you need to liquidate the asset, you get the benefit of the fallen rate in the form of a high selling price for the TIPS. If you need to liquidate an I-bond when real rates have fallen sharply, you may only do so at par. The only way to maintain the benefit of having bought the i-bond when rates were higher is to keep holding it. This creates a liquidity risk for I-bonds when real rates have fallen significantly below the rate at issue.

The above also suggests a diversification benefit for TIPS and I-bonds— TIPS provide liquidity when real rates fall, and I-bonds protect principal when real rates rise.
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Re: Hidden liquidity risk with I-bonds

Post by HawkeyePierce » Mon Oct 21, 2019 10:45 pm

This is why I think of I-bonds as inflation-linked CD’s rather than bonds.

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Re: Hidden liquidity risk with I-bonds

Post by chem6022 » Mon Oct 21, 2019 11:24 pm

Problems to have. I can keep winning for up to 30 years if rates fall, but I can easily sell any time after a year if rates rise. Sounds like an awful investment.

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Re: Hidden liquidity risk with I-bonds

Post by JoMoney » Mon Oct 21, 2019 11:28 pm

The fact that it might have otherwise appreciated in value if it was a marketable security is not a "risk".
Your decision of whether or not to sell it has no bearing on it's liquidity. The fact that you're not reliant on a market to sell it if the money is needed (it's redeemed directly with the U.S. Treasury) means you don't have any of the liquidity concerns that would come with a security that has to find a buyer in a functioning market.
You also don't bear any potential downside loss in value if interest rates rise (which IS a "risk").
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Re: Hidden liquidity risk with I-bonds

Post by whodidntante » Mon Oct 21, 2019 11:36 pm

JoMoney wrote:
Mon Oct 21, 2019 11:28 pm
The fact that it might have otherwise appreciated in value if it was a marketable security is not a "risk".
Your decision of whether or not to sell it has no bearing on it's liquidity. The fact that you're not reliant on a market to sell it if the money is needed (it's redeemed directly with the U.S. Treasury) means you don't have any of the liquidity concerns that would come with a security that has to find a buyer in a functioning market.
You also don't bear any potential downside loss in value if interest rates rise (which IS a "risk").
Well, I guess words do mean things. :happy

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Re: Hidden liquidity risk with I-bonds

Post by Ferdinand2014 » Mon Oct 21, 2019 11:38 pm

Liquidity of ibonds is independent of rising or falling interest rates and interest penalty. Redeeming restrictions before 12 months is a liquidity concern only if you are unaware of this when you purchase them. Given the zero counterparty risk and a guaranteed buyer, it seems liquidity is guaranteed? Maybe I am misunderstanding.
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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Tue Oct 22, 2019 12:17 am

I’m referring to portfolio liquidity not whether you theoretically can liquidate. An asset has low liquidity in a portfolio if it is financially unattractive to liquidate it.

Suppose you have an older I-bond with a guaranteed real yield of 3%. If you needed to liquidate it, that would be painful. Another way to look at it is that if you hold it to maturity, it will have some value (in real terms). You can discount that value back to a present value using the current real yield offered of 0.5%. This will give the bond a de facto present value that is significantly higher than the par at which you can liquidate it. This is no different in practice than if you sold a security and took a big hit on selling price due to a bid-ask spread that was fairly wide, reflective of low liquidity.

To answer another reply above, I was not suggesting these are bad investments, just articulating a property not usually discussed.
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Re: Hidden liquidity risk with I-bonds

Post by nisiprius » Tue Oct 22, 2019 6:25 am

Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
I’m referring to portfolio liquidity not whether you theoretically can liquidate. An asset has low liquidity in a portfolio if it is financially unattractive to liquidate it.
I don't think that's what liquidity means, and I think using it that way is going to lead to nothing but confusion.

If I'm wrong about that, point me to something that defines "portfolio liquidity" in the same way you are using the phrase.

What you are actually talking about is zero volatility.

I don't think I've ever heard it called a "risk" of holding cash that you might be unwilling to take money out of your bank account when the stock market is booming.

Conversely, I don't think I've ever heard high volatility described as "high liquidity" in the sense that if you are determined to sell only when the asset is outperforming, if an asset has high volatility, you will get more frequent windows of opportunity to do that.
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Re: Hidden liquidity risk with I-bonds

Post by jeffyscott » Tue Oct 22, 2019 10:20 am

HawkeyePierce wrote:
Mon Oct 21, 2019 10:45 pm
This is why I think of I-bonds as inflation-linked CD’s rather than bonds.
Yes, like a 5 year CD with an early withdrawal penalty (and maybe initially also a very strict 1 year CD), then after 5 years they act more like an inflation indexed savings account.
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Re: Hidden liquidity risk with I-bonds

Post by protagonist » Tue Oct 22, 2019 10:30 am

Northern Flicker wrote:
Mon Oct 21, 2019 10:41 pm
The description of I-bonds will present two liquidity constraints— you cannot liquidate then at all for the first 12 months of holding them, and there is a penalty of a 3-month’s interest for liquidation in the first 5 years.

But there also is a more subtle, hidden liquidity risk. Consider what happens to a bond when interest rates rise and fall. If you hold a TIPS and real rates rise, the market value of the TIPS falls. By comparison, an I-bond (over 5 years old) may be cashed in at par, a benefit for the I-bond.

But now look at what happens when real rates fall. The price of the TIPS goes up. If you need to liquidate the asset, you get the benefit of the fallen rate in the form of a high selling price for the TIPS. If you need to liquidate an I-bond when real rates have fallen sharply, you may only do so at par. The only way to maintain the benefit of having bought the i-bond when rates were higher is to keep holding it. This creates a liquidity risk for I-bonds when real rates have fallen significantly below the rate at issue.

The above also suggests a diversification benefit for TIPS and I-bonds— TIPS provide liquidity when real rates fall, and I-bonds protect principal when real rates rise.
That is not what I would define as a "risk".
The purpose of I-bonds is not to make money...it is to beat (or not lose to) inflation under all conditions. That is their ONLY purpose.
If real rates fall and you cash in your I-bonds, you still meet or beat inflation. You have achieved your purpose. Thus, no significant risk (other than 3 months interest if cashed in early).

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Re: Hidden liquidity risk with I-bonds

Post by jdilla1107 » Tue Oct 22, 2019 11:16 am

Savings bonds and CDs are poor instruments to rebalance with. In my opinion, they should never compromise 100% of a fixed income portfolio. They should be used as a as a portion of the bond portfolio that you would never (within reason) need to rebalance with.

It's not a "liquidity problem" it's a "rebalancing problem". Although, if savings bonds are 100% of your bond allocation, then it can feel like a liquidity problem, because you could be forced to sell something when it is not optimal to do so.

I am a big buyer of EE bonds and they have the same problem (magnified).

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Re: Hidden liquidity risk with I-bonds

Post by jdilla1107 » Tue Oct 22, 2019 11:24 am

nisiprius wrote:
Tue Oct 22, 2019 6:25 am
Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
I’m referring to portfolio liquidity not whether you theoretically can liquidate. An asset has low liquidity in a portfolio if it is financially unattractive to liquidate it.
I don't think that's what liquidity means, and I think using it that way is going to lead to nothing but confusion.
It's reasonable to think of this as a "liquidity problem". If I am willing to always buy your house for $1, that does not resolve all possible liquidity issues with you selling your house for a reasonable price in the future. People say that TIPs had liquidity issues in 2008, but they don't mean "NO one would ever buy them". They mean the price was somewhat more distressed.

The difference with i-bonds is that the floor is pretty high, so the liquidity issue does not feel "distressed". There is a difference between saying "there is no liquidity available at any price" and "the liquidity available is at a sup-optimal price".

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Re: Hidden liquidity risk with I-bonds

Post by #Cruncher » Tue Oct 22, 2019 11:36 am

jeffyscott wrote:
Tue Oct 22, 2019 10:20 am
… after 5 years they act more like an inflation indexed savings account.
Not really. The interest rate on a savings account tends to move up and down with market rates. But the fixed rate on an I bond stays the same for 30 years. While I don't think I'd use the term "liquidity risk", I agree with the original poster's point. He illustrates it in his 2nd post:
Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
Suppose you have an older I-bond with a guaranteed real yield of 3%. If you needed to liquidate it, that would be painful. ... This is no different in practice than if you sold a security and took a big hit on selling price due to a bid-ask spread that was fairly wide, reflective of low liquidity.
This is especially relevant if one buys I bonds as part of an emergency fund. They cease serving this function well if market interest rates rise fall significantly. (Edited to change "rise" to "fall" in previous sentence. Oops!)
Last edited by #Cruncher on Tue Oct 22, 2019 3:18 pm, edited 1 time in total.

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Tue Oct 22, 2019 12:45 pm

I don't think that's what liquidity means, and I think using it that way is going to lead to nothing but confusion.

If I'm wrong about that, point me to something that defines "portfolio liquidity" in the same way you are using the phrase.
When people have an emergency fund or hold 5% of a portfolio in cash for liquidity even when investing liquid stock and bond index funds, this notion of liquidity is being used.

But quibbling about the best name for the effect is a distraction. The effect is there. If you have an I-bond with a guaranteed real yield that is higher than the current prevailing real yield, then its present value is always greater than the liquidation value if you hold it either until real yields exceed the real yield of the bond or to maturity, whichever comes first.
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Re: Hidden liquidity risk with I-bonds

Post by HomerJ » Tue Oct 22, 2019 1:02 pm

protagonist wrote:
Tue Oct 22, 2019 10:30 am
The purpose of I-bonds is not to make money...it is to beat (or not lose to) inflation under all conditions. That is their ONLY purpose.
If real rates fall and you cash in your I-bonds, you still meet or beat inflation. You have achieved your purpose. Thus, no significant risk (other than 3 months interest if cashed in early).
This.
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Re: Hidden liquidity risk with I-bonds

Post by nisiprius » Tue Oct 22, 2019 1:10 pm

Northern Flicker wrote:
Tue Oct 22, 2019 12:45 pm
...When people have an emergency fund or hold 5% of a portfolio in cash for liquidity even when investing liquid stock and bond index funds, this notion of liquidity is being used...
To me, "liquidity" in an emergency fund means being able to get currency out of an ATM machine in hours--or a teller's check as soon as the bank opens--as opposed to waiting for a transaction to settle and an ACH transfer to complete and the money to show up as "available" in a bank account.

I'm not trying to be argumentative, I'm saying that's what I always understood people to mean when they said that emergency funds should be "liquid."
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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Tue Oct 22, 2019 2:36 pm

Terminology aside, I-bonds and TIPS have sufficiently different properties to provide a diversification opportunity. If you hold some I-bonds and TIPS that were bought when real yields were 3% and you need to sell one of them, you would get more value from selling the TIPS. If both were bought when real yields were 0.1%, you would get more value from selling the I-bond.

Thus holding a mix of the two protects against having to sell either one when rates moved in the unfavorable direction for that bond type.

The idea that because the only purpose of an I-bond is to beat inflation, you should not care if you sell one with a 3% yield today is a specious argument. That may be your purpose, but my purpose would be to beat inflation by the amount of the guaranteed yield. If the govt announced that they were changing the rules and modifying the real yields on all I-bonds to 0.1%, I don’t think we would see people posting that this is ok because the only purpose of I-bonds is to beat inflation and you still will beat inflation.

Lastly, if there were a secondary market for I-bonds but you could only find a buyer willing to buy one at par despite the bond having appreciated from falling rates, we would not be in disagreement that this is a liquidity issue. The fact that there is no secondary market and the govt redeems it at par instead of another investor buying it at par is the only difference.
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Re: Hidden liquidity risk with I-bonds

Post by JackoC » Tue Oct 22, 2019 3:12 pm

#Cruncher wrote:
Tue Oct 22, 2019 11:36 am
jeffyscott wrote:
Tue Oct 22, 2019 10:20 am
… after 5 years they act more like an inflation indexed savings account.
Not really. The interest rate on a savings account tends to move up and down with market rates. But the fixed rate on an I bond stays the same for 30 years. While I don't think I'd use the term "liquidity risk", I agree with the original poster's point. He illustrates it in his 2nd post:
Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
Suppose you have an older I-bond with a guaranteed real yield of 3%. If you needed to liquidate it, that would be painful. ... This is no different in practice than if you sold a security and took a big hit on selling price due to a bid-ask spread that was fairly wide, reflective of low liquidity.
This is especially relevant if one buys I bonds as part of an emergency fund. They cease serving this function well if interest rates rise significantly.
I also agree with both points whether or not 'liquidity risk' is the right way to put it. If you view I-bonds as any kind of 'trading asset': they are great if real rates go up a lot since you get to cash them in at par. Not great if real rates fall a lot since you can only cash them in at par. And similarly old I-bonds with fixed rates way above current TIPS yields don't work well anymore as 'emergency fund' assets since selling them is giving up a higher real 'riskless' yield than you might ever again get anywhere else.

Now, whether either of those things is highly relevant to buying I-bonds now is questionable IMO. The problem of old high yielding I-bonds as 'emergency fund' has an obvious solution: gradually put aside new cash as the 'emergency fund' and just enjoy the inflation+2-3% 'riskless' return on the old I-bonds. Nor as others have mentioned are I-bonds very suitable for 'rebalancing' so if neither 'emergency fund' nor for 'rebalancing' why would you have to sell them?

Also the black swan downside of all 'riskless' US govt bonds is that the US fiscal path causes the market to start to seriously doubt long term US credit. I-bonds have a big advantage there of being redeemable at par if say the market starts giving a moderate but obvious credit haircut to long term TIPS. So it's realistic to say 'I'll wait till the market worries at all about US credit before I start worrying about it'. For marketable securities that's less realistic. If a moderate credit haircut works its way into long term marketable US bond prices, the strong temptation will be to 'hang on' hoping it goes way, then bail out at a bigger loss if it gets worse.

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Tue Oct 22, 2019 3:54 pm

Nor as others have mentioned are I-bonds very suitable for 'rebalancing' so if neither 'emergency fund' nor for 'rebalancing' why would you have to sell them?
Portfolio withdrawals during decumulation is another reason for liquidating assets. Current yields on i-bonds are at 0.5%. I-bond rates have not ever gone negative, even when TIPS real yields were negative, but going back to zero or 0.1% would not be a shocker if real rates fall, so I would not say that this thread is irrelevant to bonds purchased today.
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Re: Hidden liquidity risk with I-bonds

Post by lazyday » Tue Oct 22, 2019 6:15 pm

Whatever you call it, I do agree that it’s possible to lose value when redeeming I bonds or CDs before maturity.

Of course we gain value when redeeming before maturity if rates have risen, so if we have the flexibility to hold if rates fall and sell if they rise, then overall there is a benefit.

For some of us, I bonds are only a small portion of our fixed income. I don’t worry about what happens when rates drop: if I redeem then I will lose value, but I expect to be able to just hold them without much trouble.

It’s a real consideration for someone whose FI is mostly I bonds, but there are big benefits to I bonds and I wouldn’t jump too quickly to add TIPS without some thought.

With CDs I’m trying to have a yearly ladder so that I can rebalance when one matures. In reality the ladder is somewhat haphazard with missing rungs. I’m willing to wait and possibly miss a good rebalancing opportunity. I put more consideration into yield than making a nice ladder, but I suppose someone could carefully construct a ladder with CDs maturing every 6 months.

In the past, people have posted about owning both bonds and CDs so they can rebalance when needed, but I don’t worry about it so much. If I don’t fill in the worst hole in my ladder, then I’ll have a 2.5 year period with no rebalancing into stocks, unless rates are high enough to break a CD. If there’s a deflationary panic in those years, instead of rebalancing I might move toward more risky stocks.

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Re: Hidden liquidity risk with I-bonds

Post by Silence Dogood » Wed Oct 23, 2019 10:02 am

#Cruncher wrote:
Tue Oct 22, 2019 11:36 am
Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
Suppose you have an older I-bond with a guaranteed real yield of 3%. If you needed to liquidate it, that would be painful. ... This is no different in practice than if you sold a security and took a big hit on selling price due to a bid-ask spread that was fairly wide, reflective of low liquidity.
This is especially relevant if one buys I bonds as part of an emergency fund. They cease serving this function well if market interest rates rise fall significantly. (Edited to change "rise" to "fall" in previous sentence. Oops!)
Is it really still an emergency fund if one is unwilling to actually spend the money on an emergency?

I think there is a difference between unwilling and unable.

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Re: Hidden liquidity risk with I-bonds

Post by Broken Man 1999 » Wed Oct 23, 2019 10:33 am

Silence Dogood wrote:
Wed Oct 23, 2019 10:02 am
#Cruncher wrote:
Tue Oct 22, 2019 11:36 am
Northern Flicker wrote:
Tue Oct 22, 2019 12:17 am
Suppose you have an older I-bond with a guaranteed real yield of 3%. If you needed to liquidate it, that would be painful. ... This is no different in practice than if you sold a security and took a big hit on selling price due to a bid-ask spread that was fairly wide, reflective of low liquidity.
This is especially relevant if one buys I bonds as part of an emergency fund. They cease serving this function well if market interest rates rise fall significantly. (Edited to change "rise" to "fall" in previous sentence. Oops!)
Is it really still an emergency fund if one is unwilling to actually spend the money on an emergency?

I think there is a difference between unwilling and unable.
Ha! good point!

If I had an emergency need, my I-bonds paying 3.0% and 3.6% + inflation adjustment would be way, way down on my "what to sell" list.

The definition of liquidity is pretty simple: Financial liquidity refers to how easily assets can be converted into cash. That is it.

Where the redeeming of an I-bond might be or not be the best outcome for the portfolio is irrelevant, IMHO. Liquidating any number of types of financial assets exposes the portfolio to both gains, and loses. But that has no bearing on the liquidity of the asset. What one receives (or gives up) in a liquidation is irrelevant. It doesn't affect the liquidity of the asset.

OP, I agree that a person such as myself holding I-bonds paying such high fixed rates is very reluctant to sell such an I-bond. But, my feeling about selling (or not) has ZERO bearing on the liquidity of the I-bond. My I-bonds have no idea what I care about them.

Your title isn't a good one. There is no liquidity risk for an I-bond. I think what you are describing is an investor's behavior. The investor's reluctance to sell the bond does not translate to being a liquidity issue.

Broken Man 1999

ETA: OP, you are correct on one item. An I-bond is NOT a liquid asset for the first 12 months. After that, very liquid.
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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Sat Oct 26, 2019 3:07 am

It is clear to me that the govt did a great job of hiding the risk. Liquidity is not an all-or-nothing thing. You can buy liquidity by the lowering the price at which you will sell an item. IBonds simulate that if redeemed when real rates have fallen after the bond has been issued.
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Re: Hidden liquidity risk with I-bonds

Post by lazyday » Sat Oct 26, 2019 5:19 am

Northern Flicker wrote:
Sat Oct 26, 2019 3:07 am
It is clear to me that the govt did a great job of hiding the risk.
I’d say that it’s not hidden since the terms are clear, it’s not much of a risk since you don’t lose purchasing power, and it’s not illiquidity since you can sell at the expected and agreed upon price.

I bonds could still be worthwhile even if you can't optimize all of the benefits. They might still be worthwhile even if you can't use them for educational expenses, and they might still be worthwhile even if you don't have the flexibility to avoid selling when rates fall. For example, unlike with TIPS, you maintain buying power if you sell when rates rise.

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Re: Hidden liquidity risk with I-bonds

Post by JBTX » Sat Oct 26, 2019 11:27 am

Northern Flicker wrote:
Sat Oct 26, 2019 3:07 am
It is clear to me that the govt did a great job of hiding the risk. Liquidity is not an all-or-nothing thing. You can buy liquidity by the lowering the price at which you will sell an item. IBonds simulate that if redeemed when real rates have fallen after the bond has been issued.
First if you might need the money in one year don't invest in them. Ibonds are not the same thing as cash.

As to the 3 month interest penalty, that is a pretty small penalty in the unlikely event you will need the money. Chances are the impact it isn't any more than they typical term structure of interest rates

I bonds are unique in that you can lock in a higher real rate, but can choose to liquidate if real rates go down, subject to the limitations above. Also they have the unique characteristic of tax deferral.

You aren't going to get rich on ibonds but they are a suitable investment for an extended emergency / liquidity fund.

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Re: Hidden liquidity risk with I-bonds

Post by jdilla1107 » Sat Oct 26, 2019 11:43 am

Broken Man 1999 wrote:
Wed Oct 23, 2019 10:33 am

The definition of liquidity is pretty simple: Financial liquidity refers to how easily assets can be converted into cash. That is it.
This is not correct. Price definitely plays a role in the definition.

From wikipedia:

https://en.wikipedia.org/wiki/Market_liquidity

In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much. In a relatively illiquid market, selling it quickly will require cutting its price by some amount.[1][2]

If I am willing to immediately buy your house at any time in the future for $1, that does not make your house a liquid investment.

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Re: Hidden liquidity risk with I-bonds

Post by Silence Dogood » Sat Oct 26, 2019 12:05 pm

jdilla1107 wrote:
Sat Oct 26, 2019 11:43 am
Broken Man 1999 wrote:
Wed Oct 23, 2019 10:33 am

The definition of liquidity is pretty simple: Financial liquidity refers to how easily assets can be converted into cash. That is it.
This is not correct. Price definitely plays a role in the definition.

From wikipedia:

https://en.wikipedia.org/wiki/Market_liquidity

In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much. In a relatively illiquid market, selling it quickly will require cutting its price by some amount.[1][2]

If I am willing to immediately buy your house at any time in the future for $1, that does not make your house a liquid investment.
Is market liquidity the same thing as financial liquidity?

https://www.investopedia.com/articles/ ... idity.asp

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Re: Hidden liquidity risk with I-bonds

Post by jdilla1107 » Sat Oct 26, 2019 12:25 pm

Silence Dogood wrote:
Sat Oct 26, 2019 12:05 pm
jdilla1107 wrote:
Sat Oct 26, 2019 11:43 am
Broken Man 1999 wrote:
Wed Oct 23, 2019 10:33 am

The definition of liquidity is pretty simple: Financial liquidity refers to how easily assets can be converted into cash. That is it.
This is not correct. Price definitely plays a role in the definition.

From wikipedia:

https://en.wikipedia.org/wiki/Market_liquidity

In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much. In a relatively illiquid market, selling it quickly will require cutting its price by some amount.[1][2]

If I am willing to immediately buy your house at any time in the future for $1, that does not make your house a liquid investment.
Is market liquidity the same thing as financial liquidity?

https://www.investopedia.com/articles/ ... idity.asp
Price is just an embedded assumption in that definition. It's inside of the words "easily" and "smoothly". For example, from that page:

"For example, if an investor was to sell to another collector, they might get full value if they wait for the right buyer. However, the item could be sold at a discount to its value if done through a dealer or broker if cash was needed."

When people talk about liquidity without price, they are just assuming selling for a "reasonable price". I assure you there are lots of people in this world who will pay cash very quickly if you are willing to take 50-90% less than than the market value for something.

Warren Buffet stepped stepped up for Goldman Sachs in the financial crisis. The liquidity crisis was based on bank s not being able to get "reasonable" prices for their assets.

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Re: Hidden liquidity risk with I-bonds

Post by shess » Sat Oct 26, 2019 12:50 pm

Broken Man 1999 wrote:
Wed Oct 23, 2019 10:33 am
OP, I agree that a person such as myself holding I-bonds paying such high fixed rates is very reluctant to sell such an I-bond. But, my feeling about selling (or not) has ZERO bearing on the liquidity of the I-bond. My I-bonds have no idea what I care about them.
Yeah, I agree. If I managed to have a 5% CD in my cash reserves, I would prefer to sell other lower-yielding items before that CD. But if I needed the cash, away it goes.

If you amp the returns up enough, say to 8%, I suppose you could argue that you'd prefer to sell an investment before selling that sweet CD. But even in that case, I don't think it's a "risk". The CD is still doing its job, but your cash reserves don't REQUIRE you to use them before selling investments, they just give you the option to use them before selling other investments. Today, if I had a cash crunch and had to choose between selling an 8% guaranteed instrument versus liquidating some shares, I'd 100% liquidate some shares, wouldn't even spend that long thinking about it. As long as I'm doing that by my choice, my cash reserves are doing their intended job.

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Re: Hidden liquidity risk with I-bonds

Post by Broken Man 1999 » Sat Oct 26, 2019 2:34 pm

Northern Flicker wrote:
Sat Oct 26, 2019 3:07 am
It is clear to me that the govt did a great job of hiding the risk. Liquidity is not an all-or-nothing thing. You can buy liquidity by the lowering the price at which you will sell an item. IBonds simulate that if redeemed when real rates have fallen after the bond has been issued.
I-Bonds demonstrate nothing of the kind. I-Bonds are not marketable bonds. The current market conditions have ZERO affect on the price of the existing I-Bond. New I-Bonds do have an initial connection to the market at the time they are bought. That is why the I-Bonds bought today pay far less fixed rate than the I-Bonds bought in earlier times.

However, new fixed rates do not affect the fixed rates that are already purchased. If the new I-Bond fixed rate is .001% or !0%, my I-Bond's fixed rate chugs along, unchanged.

When an I-Bond is purchased, the investor knows several things:
1. The fixed rate of the I-Bond.
2. Some unknown inflation adjustment will be paid as the bond is held by the buyer.
3. The holder must hold a year before redeeming.
4. The holder gives up some month's worth of interest if redeemed before 5 years (not sure if that is the length).
5. Each and every month the owner can know what their bond is worth, and that value has ZERO connection to the real rates you speak of. There is no fear of getting less, or more. The I-Bond will bring exactly what the I-Bond table says, no matter the current interest rate.
6. The I-Bond owner knows when the I-Bond will stop earning interest, no guess work needed.

You are giving attributes to an I-Bond they simply do not have. A marketable bond can indeed be sold for a premium (or loss) with interest rate changes. But, recall, an I-Bond is a fixed rate, non-marketable security.

Non-marketable does not mean the bond is not liquid. And, though some have lassoed and pulled in market liquidity, there is certainly no market liquidity concerns since the US Treasury is the market. There are only two possible players for an I-Bond: the owner, and the US Treasury. And, each player knows exactly what the bond is worth.

There is one risk that might be present in redeeming an I-Bond if one squints their eye hard enough: Reinvestment risk. That risk is if I redeem an I-Bond with a great fixed rate, and want to buy something like that again, there is a risk the new investment might have a substantially lower (like today) fixed interest rate. But, I would get every bit of my investment promised. Reinvestment risk also is not liquidity risk.

I-Bonds do not act like other bonds. But, they are highly liquid, and one will not gain (or lose) a penny from the stated known worth at redemption.

If one has bought I-Bonds expecting they could be sold for a price having any connection to the current interest rate, they simply did not understand what they were buying.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven than I shall not go. " -Mark Twain

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Sat Oct 26, 2019 3:21 pm

I-Bonds demonstrate nothing of the kind. I-Bonds are not marketable bonds. The current market conditions have ZERO affect on the price of the existing I-Bond.
That’s why the liquidity is hidden. I-bonds are very worthy investments, I’m not suggesting otherwise. But they have a notional value which is the (real) present value of the future cash flows. This is the value you get if you hold them to maturity. You cannot realize their notional value by liquidating them if rates have fallen.

A good comparison would be a broker CD. These are not very liquid. You probably always can find a bid to buy one, just not at a price close to their notional market value. The mechanics of liquidating an I-bond are different, but the effect is similar. Unlike broker CDs, i-bonds are asymmetric. If rates rise (or stay flat) I-bonds remain perfectly liquid and have the benefit of liquidating at par even though the notional present value of holding the bond to maturity is lower than par. This is the compensation to the investor for taking on the defect of having to give up notional present value to liquidate if rates have fallen.
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Re: Hidden liquidity risk with I-bonds

Post by Silence Dogood » Sat Oct 26, 2019 4:10 pm

jdilla1107 wrote:
Sat Oct 26, 2019 12:25 pm
"For example, if an investor was to sell to another collector, they might get full value if they wait for the right buyer. However, the item could be sold at a discount to its value if done through a dealer or broker if cash was needed."

When people talk about liquidity without price, they are just assuming selling for a "reasonable price". I assure you there are lots of people in this world who will pay cash very quickly if you are willing to take 50-90% less than than the market value for something.
I'm confused about how this is relevant to Series I Savings Bonds.

There are no brokers/dealers involved (other than the Treasury itself). No need to sell at 50-90% discount. There is no uncertainty about how much the Savings Bonds are worth. The Treasury won't refuse to cash them.

If someone is unwilling to cash Savings Bonds due to an emergency, then Savings Bonds should not be part of their emergency fund.

“There seems to be some perverse human characteristic that likes to make easy things difficult.”
-Warren Buffett

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Re: Hidden liquidity risk with I-bonds

Post by lazyday » Sat Oct 26, 2019 4:24 pm

Northern Flicker wrote:
Sat Oct 26, 2019 3:21 pm
A good comparison would be a broker CD.
An I bond isn't much like a brokered CD.

It's more like a direct CD, especially the ones you used to get with a small early withdrawal penalty. Ally bank used to sell CDs with 90 day early withdrawal penalties.

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Re: Hidden liquidity risk with I-bonds

Post by jdilla1107 » Sat Oct 26, 2019 8:40 pm

Silence Dogood wrote:
Sat Oct 26, 2019 4:10 pm
jdilla1107 wrote:
Sat Oct 26, 2019 12:25 pm
"For example, if an investor was to sell to another collector, they might get full value if they wait for the right buyer. However, the item could be sold at a discount to its value if done through a dealer or broker if cash was needed."

When people talk about liquidity without price, they are just assuming selling for a "reasonable price". I assure you there are lots of people in this world who will pay cash very quickly if you are willing to take 50-90% less than than the market value for something.
I'm confused about how this is relevant to Series I Savings Bonds.

There are no brokers/dealers involved (other than the Treasury itself). No need to sell at 50-90% discount. There is no uncertainty about how much the Savings Bonds are worth. The Treasury won't refuse to cash them.

If someone is unwilling to cash Savings Bonds due to an emergency, then Savings Bonds should not be part of their emergency fund.

“There seems to be some perverse human characteristic that likes to make easy things difficult.”
-Warren Buffett
Did you even read the original post? In certain cases liquidating i-bonds means doing so below market value.

“Everything should be made as simple as possible, but no simpler.”
-Albert Einstein

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Sat Oct 26, 2019 10:39 pm

I'm confused about how this is relevant to Series I Savings Bonds.

There are no brokers/dealers involved (other than the Treasury itself). No need to sell at 50-90% discount. There is no uncertainty about how much the Savings Bonds are worth. The Treasury won't refuse to cash them.
You are focusing on the process or mechanics of liquidation, instead of the end result.
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Re: Hidden liquidity risk with I-bonds

Post by Silence Dogood » Fri Nov 01, 2019 7:29 pm

jdilla1107 wrote:
Sat Oct 26, 2019 8:40 pm
Silence Dogood wrote:
Sat Oct 26, 2019 4:10 pm
jdilla1107 wrote:
Sat Oct 26, 2019 12:25 pm
"For example, if an investor was to sell to another collector, they might get full value if they wait for the right buyer. However, the item could be sold at a discount to its value if done through a dealer or broker if cash was needed."

When people talk about liquidity without price, they are just assuming selling for a "reasonable price". I assure you there are lots of people in this world who will pay cash very quickly if you are willing to take 50-90% less than than the market value for something.
I'm confused about how this is relevant to Series I Savings Bonds.

There are no brokers/dealers involved (other than the Treasury itself). No need to sell at 50-90% discount. There is no uncertainty about how much the Savings Bonds are worth. The Treasury won't refuse to cash them.

If someone is unwilling to cash Savings Bonds due to an emergency, then Savings Bonds should not be part of their emergency fund.

“There seems to be some perverse human characteristic that likes to make easy things difficult.”
-Warren Buffett
Did you even read the original post? In certain cases liquidating i-bonds means doing so below market value.

“Everything should be made as simple as possible, but no simpler.”
-Albert Einstein
I did read the original post.

The disagreement here is largely based off of definitions.

For example, I have a difficult time understanding how a U.S. savings bond, which is a non-marketable security, can be liquidated below market value.

Isn't the market value of a savings bond whatever the U.S. Treasury agreed to pay for it when the savings bond was originally purchased?

Sure, it would be nice if one could sell their savings bond on the market for a higher price, but that's not how savings bonds work. One knows this when they purchase the savings bond in the first place.

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Re: Hidden liquidity risk with I-bonds

Post by Kevin M » Fri Nov 01, 2019 8:06 pm

As others have pointed out, the limited downside due to an early withdrawal option, but no upside due to lack of secondary market, is the same for most direct CDs (as opposed to brokered CDs, which can be bought and sold on secondary market, but definitely have poor liquidity in the form of commissions and large bid/ask spreads).

I've never thought of the lack of upside with direct CDs or I Bonds as a liquidity risk, but then I don't count on direct CDs (or I Bonds) for liquidity in a falling rate scenario. It's an interesting perspective, though.

The limited downside of a direct CD (or I Bond) due to the early withdrawal option (assuming reasonable early withdrawal penalty) is much more important, and extremely valuable in reducing term risk, relative to a Treasury of same maturity, for example. If you want some upside for a falling rate scenario, you'll want to hold something besides direct CDs or I Bonds. I hold bond funds for that, but still hold lots of fixed income in direct CDs.

One benefit of CDs over I Bonds is that if you've been buying them for a few years, sticking with maturities of 7 years or less, you are likely to have CDs maturing periodically, and that contributes to liquidity for likely rebalancing scenarios. With a 30-year maturity, I Bonds don't have that same advantage.

I'm getting rid of my I Bonds this year (most gone already) as they hit their 5-year mark. I decided it wasn't worth dealing with TreasuryDirect for my relatively small amount of I Bonds, the amount of inflation hedging from them being minuscule relative to my portfolio size.

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Re: Hidden liquidity risk with I-bonds

Post by Silence Dogood » Fri Nov 01, 2019 8:16 pm

Kevin M wrote:
Fri Nov 01, 2019 8:06 pm
I'm getting rid of my I Bonds this year (most gone already) as they hit their 5-year mark. I decided it wasn't worth dealing with TreasuryDirect for my relatively small amount of I Bonds, the amount of inflation hedging from them being minuscule relative to my portfolio size.
Do you have any paper I bonds that you plan to keep?

I do not have a Treasury Direct account but I do own some paper I bonds.

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Re: Hidden liquidity risk with I-bonds

Post by Kevin M » Fri Nov 01, 2019 8:32 pm

Silence Dogood wrote:
Fri Nov 01, 2019 8:16 pm
Kevin M wrote:
Fri Nov 01, 2019 8:06 pm
I'm getting rid of my I Bonds this year (most gone already) as they hit their 5-year mark. I decided it wasn't worth dealing with TreasuryDirect for my relatively small amount of I Bonds, the amount of inflation hedging from them being minuscule relative to my portfolio size.
Do you have any paper I bonds that you plan to keep?

I do not have a Treasury Direct account but I do own some paper I bonds.
Had some, redeemed them. Not worth the hassle.

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Sun Nov 03, 2019 12:38 am

For example, I have a difficult time understanding how a U.S. savings bond, which is a non-marketable security, can be liquidated below market value.
They have no market value. They have a redemption value.

Liquidity risk is the risk that the value received by liquidating an investment is significantly less than the value of continuing to hold the investment. This is certainly an issue with I-bonds issued say in Nov. 2000. The real yield is 3.4%. You would get much more value by continuing to hold it than by liquidating it, despite no applicable early withdrawal penalty.
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Re: Hidden liquidity risk with I-bonds

Post by ivk5 » Sun Nov 03, 2019 12:44 am

Northern Flicker wrote:
Sun Nov 03, 2019 12:38 am
Liquidity risk is the risk that the value received by liquidating an investment is significantly less than the value of continuing to hold the investment.
As noted upthread, this appears to be a novel definition.

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Re: Hidden liquidity risk with I-bonds

Post by Northern Flicker » Sun Nov 03, 2019 1:01 am

It’s not novel in the professional investment community.

This represents a diversification opportunity with TIPS. If you have assets intended to provide portfolio liquidity, such as if you are retired or using it for an emergency fund if not retired, instead of holding cash, hold such funds as a 50-50 mix of i-bonds and TIPS. When you need to raise cash, if real rates have fallen, sell some TIPS. If real rates have risen, liquidate some I-bonds. This should perform better than cash without any significant downside.

I will refrain from explaining why one might consider doubling the size of such an emergency fund or allocation for liquidity, and why that is likely still better than holding cash.

Similarly, if someone uses a bucket approach to retirement withdrawals, instead of holding a year of expenses in cash and a year in short-term TIPS, hold a year in seasoned I-bonds (which will require some planning) and a year in short-term TIPS (e.g. VTIP). Then when real rates have fallen, the TIPS are year 1 and the I-bonds are year 2 if you need to tap these funds during a bear market, but the I-bonds are year 1 and the TIPS year 2 if real rates have risen.
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Re: Hidden liquidity risk with I-bonds

Post by shess » Wed Nov 06, 2019 10:34 pm

Kevin M wrote:
Fri Nov 01, 2019 8:06 pm
One benefit of CDs over I Bonds is that if you've been buying them for a few years, sticking with maturities of 7 years or less, you are likely to have CDs maturing periodically, and that contributes to liquidity for likely rebalancing scenarios. With a 30-year maturity, I Bonds don't have that same advantage.
I don't really think this is fair - after 30 years the iBonds stop accruing interest, but after the 5-year seasoning period, you can sell at any time with no penalty, if that is what your cashflow situation warrants. I consider them kind of like a longer-term CD with funky rollover options.

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Re: Hidden liquidity risk with I-bonds

Post by Kevin M » Thu Nov 07, 2019 2:37 pm

shess wrote:
Wed Nov 06, 2019 10:34 pm
Kevin M wrote:
Fri Nov 01, 2019 8:06 pm
One benefit of CDs over I Bonds is that if you've been buying them for a few years, sticking with maturities of 7 years or less, you are likely to have CDs maturing periodically, and that contributes to liquidity for likely rebalancing scenarios. With a 30-year maturity, I Bonds don't have that same advantage.
I don't really think this is fair - after 30 years the iBonds stop accruing interest, but after the 5-year seasoning period, you can sell at any time with no penalty, if that is what your cashflow situation warrants. I consider them kind of like a longer-term CD with funky rollover options.
Good point. As an example, I have sold all but one batch of I Bonds this year that are at or beyond the 5-year mark. Last batch goes in December. No more I Bonds for me.

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