More evidence: Why I Bonds are a no-brainer buy

Posted on November 4, 2013 by Tipswatch

Four days into November, and I am still amazed that the U.S. Treasury added a 0.2% fixed base rate to its Savings I Bonds purchased from Nov. 1, 2013 to April 30, 2014. OK, it is true that 0.2% is going to earn you very little interest ($20 a year on a $10,000 investment, growing with inflation). But it was basically a gift from the Treasury, because it keeps I Bonds the super-hero of super safe investments.

The way I Bonds work. An I Bond is a security that earns interest based on combining a fixed rate and an inflation rate.

The fixed rate – now 0.2% for as long as you hold the bond, up to 30 years – will never change. So if you bought an I Bond earlier this year with a zero fixed rate, it will continue to have a zero fixed rate. Purchases through April 30, 2014, will have a fixed rate of 0.20%. I Bonds I bought back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.

The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 1.18% annualized. It will adjust again on May 1, 2014, for all I Bonds, no matter when they were purchased. (Although the effective start date of the new interest rate can vary depending on the month you bought the I Bond, a Treasury oddity.)

Why they are a great investment.

  • First, I Bonds are the most conservative and most safe of all investments. Your principal is 99.9999999% safe and it will never decline, ever. If inflation falls to below zero, the inflation-adjusted rate will fall to zero, but not below zero. This is not true of TIPS, where accrued principal declines when deflation strikes. This means I Bonds are a superior investment to TIPS in times of deflation.
  • I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.
  • I Bonds protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate.
  • I Bonds allow you to defer federal income taxes until you redeem them, so you pay zero in taxes until they are sold. This is a big advantage over TIPS, which carry current-year income taxes for both the coupon rate and the inflation adjustment to principal. (Both TIPS and I Bonds are free of state income taxes, an advantage over bank CDs.)
  • I Bonds are very simple to track as an investment. Just download the Savings Bond Wizard, update your information, and check it a couple times a year. This is another huge advantage over TIPS held at TreasuryDirect, which is a do-it-yourself proposition, even for downloading yearly tax forms. Want to track current value of your TIPS? Open up Excel and get to work. TreasuryDirect is not going to tell you.

So with all these I Bond advantages, how do they compare with other super-safe investments? I contend that that tax advantages alone make an I Bond paying a fixed rate of 0.2, plus inflation, preferable to all super-safe investments through 10-year maturities.

I Bond Treasury TIPS Bank CD
1 year Inflation plus 0.2%* 0.09% Inflation minus 1.16% 1.00%
5 years Inflation plus 0.2% 1.35% Inflation minus 0.59% 1.95%
10 years Inflation plus 0.2% 2.59% Inflation plus 0.45% NA
30 years Inflation plus 0.2% 3.68% Inflation plus 1.35% NA
* 3-month interest penalty

The 10-year TIPS pays 0.45% plus inflation, only 25 basis points better than the I Bond. But if held in a taxable account, you’d owe taxes every year on both interest and the principal adjustment. Compare TIPS and I Bonds.

Conclusion. I Bonds outshine other super-safe investments in the short term, and their tax advantages make them attractive to hold for the long term.  Because you can buy only $10,000 a year per person (plus your income tax refund, if you wish), I say continue to buy them to the max each year and sell them only if you need cash.

Posted in I Bond, Investing in TIPS | 3 Comments

Amazing news: Treasury adds 0.20% fixed rate to the I Bond

Posted on November 1, 2013 by Tipswatch

The U.S. Treasury just announced that I Bonds purchased from Nov. 1, 2013, to April 30, 2014, will pay a fixed-rate of 0.20%, along with an inflation-adjusted rate of 1.18% (annualized) over the next six months. That means I Bonds purchased during this period will pay 1.38% annualized.

The inflation-adjusted rate will change again on May 1, 2014, but that fixed rate of 0.20% will remain with these new I Bonds for 30 years.

This is big news because the fixed rate on I Bonds has been zero since May 2010, and it appeared almost certain that the Treasury would keep the rate at zero, given the recent decline in TIPS yields. The yield on a 10-year TIPS for example, peaked at 0.92% on Sept. 5. But then the Fed backed off on tapering and the yield has dropped a nasty 52 basis points.

So this makes these I Bonds a screaming good buy. I’ve been looking at the spreads between the I Bond yield and a 10-year TIPS. It looked to me that it would take a yield of 1.2% on the TIPS to cause Treasury to move the I Bond above zero. With a 10-year TIPS currently trading at 0.40%, that squeezes the spread down to 20 basis points.

Date I Bond fixed interest TIPS yield TIPS spread over I Bond
Nov 1 2013 0.20 0.40 0.20
May 1 2010 0.20 1.32 1.12
Nov 1 2009 0.30 1.41 1.11
May 1 2009 0.10 1.80 1.70
Nov 1 2008 0.70 3.09 2.39
May 1 2008 0.00 1.52 1.52

This is a deal because I Bonds are a much more flexible and investor-friendly product than TIPS. Taxes are deferred until the I Bond is sold (for TIPS, both interest and inflation adjustment is taxable each year), and I Bonds can be sold after one year with a minor penalty and after five years with no penalty.

Should I sell my zero-rate I Bonds to buy these?

I would say definitely not, especially if you are trying to build a large cache of I Bonds by buying to the maximum each year ($10,000 per person at TreasuryDirect). If you haven’t bought your 2013 allotment because you were waiting to see if you could get a fixed rate, you just got a very nice present from the Treasury. Buy now.

Otherwise, the rest of us will be able to grab this 0.20% interest rate in January, when we can again buy I Bonds up to the limit.

Selling your I Bonds is not a good idea, I think, unless you need the cash. Because you can only buy $10,000 a year, you can only swap $10,000 a year, old for new, but your total investment in I Bonds then would be stable, not growing.

Here is the Treasury’s statement, which includes some nice information:

I Bond Earnings Rate of 1.38% includes a Fixed Rate of 0.20%
The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate. The 1.38% earnings rate for I bonds bought from November 2013 through April 2014 applies for the first six months after the issue date. The earnings rate combines a 0.20% fixed rate of return with the 1.18% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The CPI-U increased from 232.773 in March 2013 to 234.149 in September 2013, a six-month increase of 0.59%.

Posted in I Bond, Investing in TIPS, Savings Bond | 11 Comments

No surprise: Federal Reserve decides against tapering

Posted on October 30, 2013 by Tipswatch

The Federal Reserve just released its FOMC statement for it October meeting, noting that the Fed will continue its bond-buying stimulus program despite signs that the economy is improving. This was universally expected, especially in view of  upcoming budget and debt-limit showdowns in Congress.

” … the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

“Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. “

The Fed also noted that the current rate of inflation (just 1.2% over the last 12 months) is below its target of 2%.

“The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”

Posted in Investing in TIPS | Leave a comment

U.S. inflation increased 0.2% in September

Posted on October 30, 2013 by Tipswatch

The Bureau of Labor Statistics today released its shutdown-delayed September inflation report, showing that ‘headline’ inflation increased a seasonally-adjusted 0.2% in September, a number matching expectations.

Over the last 12 months, this index, known as the Consumer Price Index for All Urban Consumers (CPI-U), has ticked up just 1.2%, far below the Federal Reserve’s target of 2.o% and potential danger level of 2.5%.

The non-seasonally-adjusted CPI-U, which is used to adjust the principal balance of TIPS and set future inflation-adjusted interest rates on I Bonds, rose just 0.1% for the month and 1.2% for the last 12 months.

I Bond interest. The September number was the last piece of data needed to set the I Bond inflation-adjusted interest rate for November 2013 to April 2014. Based on my quick calculation, it looks like the new annualized interest rate will remain close to the current 1.18%. I’ll update when I find this number.

I Bonds also carry a permanent interest rate, which has been set at zero since May 2010. It is highly unlikely that the rate will rise above zero on Nov. 1.

Looking at September inflation. Inflation remained muted despite a fairly strong up-tick in the cost of gasoline (0.8%), fuel oil (0.9%) and piped gas service (1.8%). Food prices were flat and apparel dropped 0.5%.

‘Core’ inflation, which strips out food and energy and is closely watched by the Federal Reserve, increased just 0.1% in September, the same as in August, and is up a mild 1.7% for the 12 months ending in August.

The September numbers continue a trend of very mild inflation, especially since March 2013, a trend that leaves the door open for continued bond-buying stimulus by the Federal Reserve. The short-term effect is likely to be mildly positive for TIPS, meaning lower yields. However, longer-term, TIPS will lose support from investors if inflation is a non-factor and the Federal Reserve ever hints at stopping its bond-buying.

inflation

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30-year TIPS reissue auctions at 1.33%

Posted on October 24, 2013 by Tipswatch

The U.S. Treasury just posted the results of its reopening of CUSIP 912810RA8, which auctioned with a yield of 1.33% for the 29-year, 4-month remaining term. Because the coupon rate on this TIPS is 0.625% – set in the original February auction – buyers will be paying about $84.37 for $100 of value, but this includes about $1.33 of inflation adjustment since the original auction on Feb. 28, 2013.

View the auction results.

Today’s yield of 1.33% is slightly less than the 1.42% this same TIPS generated in a reissue auction on June 20. TIPS and Treasury yields have been sliding lower since the Federal Reserve backed on tapering its bond-buying stimulus program in September.

Inflation breakeven rate. The nominal 30-year Treasury is trading today at 3.61%, creating an inflation breakeven rate for this TIPS of 2.28%. If inflation averages higher than 2.28% for the next 29 years, this TIPS will outperform the Treasury.

Reaction to the auction results – announced at 1 p.m. – looks positive, based on the move up in the TIP ETF right after the news:

1pmCynthia Lynn of the Wall Street Journal noted the ‘solid demand’ for this TIPS:

Direct bidders, a group that submits their bids straight to the government, bought 19.1% of the total offering—the most since June 2012. This group of buyers nearly vanished at the last 30-year TIPS sale held in June 2013.

Bloomberg’s Susanne Walker also noted that the auction was well received, even at a time of muted inflation.

“The auction went better than expected,” said Dan Mulholland, head of Treasury trading at BNY Mellon Capital Markets in New York. “There has definitely been a reach for yield and a reach for the long end. There’s a desire for inflation protection with QE in place probably for a little longer than most people expected.”

Posted in Investing in TIPS | Leave a comment