Reader question: Is there a right time to sell an I Bond?

Posted on January 14, 2012 by Tipswatch

Good question on I Bonds today from reader Dan:

From what I read here and elsewhere, that base rate of 0% holds for the full 30 years and the variable part changes each 6 months. Is it ever the case that after a year one would want to cash out the I-bond and repurchase at some higher rate? Say the base rate went up to 1%. Would you sell your 0% i-bond and repurchase? Or does this never pay off to do that?

Dan, one of the big advantages of an I Bond is that you can sell out after one year (with a three-month interest penalty) and after 5 years with no penalty, but you can also continue to hold that I Bond for 30 years. That is a great deal of flexibility. After one year, you can re-evaluate the market and make a choice.

I view the current I Bond with a base rate of 0% as a short-term investment, possibly one year and possibly longer if TIPS continue running at zero to negative base interest, before inflation.

(Traditionally TIPS have paid up to a 1 percentage-point premium over I Bonds because I Bonds have the advantage of tax-deferred interest and better deflation protection. That premium has now been reversed – TIPS under 10 years now carry a negative base rate – giving I Bonds a clear advantage.)

If, in a year, I Bonds were paying a base rate of interest of 1% versus the 0% today, it would be a no-brainer to sell the current I Bond and buy the new one. You would want to lock in that 1% interest rate premium, possibly for 30 years.

But interest rates would have to change drastically for I Bonds to pay 1%. A more likely scenario would be that I Bonds continue to pay a zero base rate but a 10-year TIPS base rate rises to 1%. In that case, you’d have an interesting choice.

Another possibility is that inflation would turn to deflation. In that case, a year from now, the current I Bond might be paying zero total interest – zero base plus zero inflation. (This happened from May to October 2009 when the six-month inflation rate was running at -2.78%, but the I Bond base rate was then 0.1%)

If that happened again, you might consider selling the I Bond and buying another investment (possibly a bank CD) with some positive interest. Or you could ride out the six months with no interest.

Here is a chart from ForBestAdvice.com that shows how the base and inflation-adjusted interest rates have changed for I Bonds:

I-Bond Rate History
Period 6- Month Semiannual
inflation rate		 Base Rate 6- month
Earnings Rate
November 1, 2011 – April 30, 2012 +1.53%
 0.00%
 3.06%
May 1, 2011 – October 31, 2011               +2.30%
 0.00%
 4.60%
November 1, 2010 – April 30, 2011 +0.37%
 0.00%
 0.74%
May 1, 2010 – October 31, 2010              +1.54%
 0.20%
 1.74%
November 1, 2009 – April 30, 2010
              +1.53%
 0.30%
 3.36%
May 1, 2009 – October 31, 2009              -2.78%
 0.10%
 0.00%
November 3, 2008 – April 30, 2009            +2.46%
 0.70%
 5.64%
May 1, 2008 – October 31, 2008           +2.42%
 1.40%
 4.84%
November 1, 2007 – April 30, 2008           +1.53% 1.20% 4.28%

People who bought I Bonds  up to April 2009 certainly made out very well, even with six months of no interest from May to October 2009. In the periods before and after, they got an excellent return.

Posted in I Bond | 3 Comments

10-year TIPS auction: The announcement

Posted on January 12, 2012 by Tipswatch

The U.S. Treasury today, as expected, announced its Jan. 19 auction of a new 10-year Treasury Inflation-Protected Security.

Here it is if you want to view it (.pdf)

But that pdf won’t tell you much. It is a 10-year TIPS, yes. It is CUSIP 912828SA9. The auction date is January 19, 2012. OK, we knew that.

What is the coupon rate, the actual base rate this TIPS will pay over the next 10 years? Well, that’s not mentioned. (For new issues, both the price and the coupon interest rate will be determined by the auction.) Let’s assume the coupon rate will be the lowest  the Treasury offers, and that is 0.125%.

That means buyers might have to ‘pay up’ for this TIPS, because the current secondary market for a 10-year TIPS is about -0.166%.

Things can change in the next week, so it’s worth watching this site to see what the market is paying for the TIPS that matures 2021 Jul 15, which is the closest comparable you can get to a 10-year new issue.

But I will warn you that TIPS auctions, especially new issues, can be very hard to predict. I readily admit that I am no expert, and I’m often surprised at the auction result.

Read more about this Jan. 19 10-year TIPS auction

Posted in Investing in TIPS | 3 Comments

Next auction: 10-year TIPS on Jan. 19, 2012

Posted on January 9, 2012 by Tipswatch

The official announcement will come Jan. 12, but we know the Treasury will auction a new 10-year TIPS, CUSIP 912828SA9, on Thursday, Jan. 19. The question is: Should we consider buying this Treasury Inflation-Protected Security?

Normally, for me, a new 10-year TIPS would be an automatic purchase, because I’ve long considered the 1o-year to be the ‘sweet spot’ for building a buy-and-hold TIPS ladder. You get a better yield over inflation than with shorter-term issues, and the 10-year holding period is about right for people nearing retirement or newly retired.

This one ought to be doubly automatic for me, since I have a 10-year TIPS, CUSIP 9128277J5, maturing Jan. 15. It you also bought this one in January 2002, you know Jan. 15 is sort of a sad graduation day. This TIPS was issued with a coupon rate of 3.375% and it auctioned with a yield to maturity of 3.48%.

In other words, this 10-year gem has paid original buyers 3.48% every year on a principal balance that has risen 27.4% with inflation over the last 10 years.  That was a mighty good investment any way you look at it, especially in a dire 10 years of stock market returns.

OK, but what about CUSIP 912828SA9? The new 10-year TIPS to be auctioned Jan. 19 certainly doesn’t qualify for gem status. It might be more of a lump of coal, but that’s for you to decide.

We don’t yet know the coupon rate, but it should be well below the 0.625% of the last new release of a 10-year TIPS, in July 2011. In the secondary market, that July TIPS is currently yielding -0.171%, as of Friday:

10 year TIPSAlthough you can’t make a direct comparison, it’s apparent that the new 10-year TIPS may auction with a negative yield, meaning that buyers will be accepting a rate of return less than the rate of inflation over the next 10 years. That has never happened in the 15-year history of 10-year TIPS auctions. Not only has it never happened, no yield has ever been close to negative for a 10-year TIPS new issue.

Here are all the 10-year new issues:

10 year TIPS historyThe 10-year TIPS auction of Jan. 19 will be interesting to watch. Will it make history with a first-ever negative yield for a 10-year TIPS? And is that still attractive to buyers?

Lump of coal? We are certainly entering uncharted waters for Treasury yields. Uncharted waters ought to make you uneasy. A negative real return over the next 10 years ought to make you uneasy. But there are no super-safe alternatives, and TIPS protect you against an unexpected rise in inflation. You can’t get that protection with a nominal 10-year Treasury (currently yielding 1.98%) or a bank CD (about 1.8% for the highest yielding 5-year CDs). That inflation protection is the key reason for buying TIPS.

One alternative, and that is … I Bonds. For my TIPS maturing Jan. 15, my first reinvestment will be in I Bonds, which also protect you against inflation, are super safe and can be used as a short-term investment. You can buy up to $10,000 per Social Security number in I Bonds at TreasuryDirect.gov.

(Thanks to commenter Jay for updating me on the new $10,000 limit for I Bonds, which was announced Jan. 4. That announcement is worth celebrating. Even if you hate Treasury Direct – which I don’t – you should consider I Bonds as an investment this year.)

The current I Bond interest rate – 3.06% – guarantees that you will receive a 1-year return of 1.53%, but probably higher, even if you sell after one year and pay a three-month interest rate penalty. If you sell after 5 years, there is no penalty.

The $20,000 limit per couple for I Bonds points them toward the small investor, but I still think they are the superior super-safe investment in January 2012, clearly superior to a 10-year TIPS paying a negative real return.

Posted in I Bond, Investing in TIPS | 6 Comments

Treasury Inflation-Protected Securities: 2011 in review

Posted on December 30, 2011 by Tipswatch

It’s certainly been an ‘interesting’ year for TIPS, with yields at somewhat attractive levels through the first half of the year and then plummeting to record lows in the second half. Here’s a look at the month-by-month auctions in 2011. Are there some lessons for investors here?

CUSIP 912828PP9

Jan. 20, 2011: A new 10-year TIPS issue is auctioned with a coupon rate of 1.125% and a yield to maturity of 1.170%. At the time, this looked like a mediocre yield, but still somewhat appealing. Today, it looks like a steal.

March 24, 2011: CUSIP 912828PP9 is reissued as a 9-year, 10-month TIPS and auctions at a yield to maturity of 0.920%.

May 19, 2011: It is again reissued as a 9-year, 8-month TIPS and auctions at a yield of 0.887%.

Looking back, all three of these auctions were winners for buyers.

CUSIP 912810QP6

Feb. 17, 2011: A new 30-year TIPS issue is auctioned with a coupon rate of 2.125% and a yield to maturity of 2.190%. This ends up being the most attractive issue of 2011.

June 23, 2011: CUSIP 912810QP6 is reissued as a 29-year, 8-month TIPS and auctions with a yield to maturity of 1.744%. Still very attractive, in our new low-rate world.

Oct. 20, 2011: This same TIPS is reissued with a 29-year, 4-month term and auctions at 0.999%. Not so attractive.

In seven months, the 30-year TIPS yield dropped from 2.19% to 0.999%. Amazing.

CUSIP 912828QD5

April 21, 2011: This new 5-year TIPS is auctioned with a coupon rate of 0.125% and a yield to maturity of -0.180%. At the time, this auction made headlines: BUYERS ACCEPT NEGATIVE INTEREST ON TIPS! Several financial columnists derided buyers as fools. I was a buyer, and I didn’t feel foolish.

August 18, 2011: CUSIP 912828QD5 is reissued as a 4-year, 9-month TIPS and auctions at a yield to maturity of -0.825%. That rate is seriously negative, and buyers seem to be signalling either 1) Armageddon or 2) high inflation is coming.

December 12, 2011: The last reissue of the year is a 4-year, 4-month TIPS that auctions at a yield of -0.877%. Again, seriously negative and very unattractive when compared with I Bonds for the small investor.

CUSIP 912828QV5

July 21, 2011: The last new issue of the year is a 10-year TIPS with a coupon rate of 0.625% and it auctions with a yield of 0.639%. Not so bad for buyers, especially since it looked like this issue might go off around 0.47% a few days earlier.

Sept. 22, 2011: CUSIP 912828QV5 is reissued as a 9-year, 10-month TIPS and it auctions with a yield of 0.078% — getting very close to a real yield of zero.

Nov. 17, 2011: It is again reissued as a 9-year, 8-month TIPS and auctions with a yield of 0.099%, still very close to zero but above the September auction.

Conclusions

If you were a TIPS trader – which I am not – those early-year purchases would have been profit machines. The lesson is that rates went down sharply in the second half of the year. Next year, could we see the reverse, with rates very low in the first half of the year and then rising in the second half?

It is possible. Keep that in mind.

As a buy-and-hold TIPS investor, and a net buyer of TIPS (buying more than mature each year) I would love to see higher rates. The current trend, though, is down and may stay down until the overall interest rates begin rising or the economy shows dramatic improvement.

Posted in Investing in TIPS | 2 Comments

Last pitch for buying I Bonds in 2011

Posted on December 4, 2011 by Tipswatch

The Treasury will auction a 5-year TIPS on Dec. 15, probably a reissue of CUSIP 912828QD5 that currently carries a yield-to-maturity of -0.980%. Yes, that is a negative, and it means buyers of this TIPS are willing to accept a rate of return nearly 1% lower than the rate of inflation for the next five years.

Why would they do that?

1) This TIPS is a super-safe investment, 2) world markets are still in turmoil and super-safe investments look attractive, 3) the Federal Reserve won’t budge on raising interest rates anytime soon, and 4) there aren’t many super-safe alternatives.

  • A 5-year nominal Treasury is paying 0.92%. That means the TIPS buyer needs inflation to run at 1.9% or more over the next 5 years to win over a nominal Treasury. Not a bad bet, plus the buyer gets protection from higher inflation.
  • The best 5-year CD is paying 1.84% (Ally Bank, as of Friday). That one actually competes pretty well with the 5-year TIPS, pushing the break-even inflation rate up to 2.82%. Before you buy that 5-year TIPS, look hard at this CD. But you would give up protection against higher-than-expected inflation.
  • On the other hand, the average 5-year bank CD is paying 1.17%, not very attractive versus the TIPS.

I Bonds, still the better investment. If you didn’t buy I Bonds before the Oct. 31 interest-rate change, go ahead, kick yourself. The six-month rate fell from 4.6% to 3.06% for the six months ending in April 2012. (Buyers get the current rate for six months after the purchase, so you could have guaranteed yourself a 2.3% 1-year return, or better.)

I Bond Nov. to April 2012Forget that 4.6% rate. If you haven’t bought I Bonds in 2011, you should still ponder this investment before Dec. 31. Here’s why: The Treasury puts yearly limits on I Bond purchases. You can buy $5,000 in Treasury Direct and $5,000 in paper bonds each year. A couple can buy twice that. Paper bonds will no longer be issued after Dec. 31, except as a tax refund.

So you could still load up on this I Bond in 2011 (paper and electronic) and then again in 2012 (just Treasury Direct purchases and your tax refund).

I Bonds currently carry a base interest rate of 0%, plus an inflation-matching interest rate that changes every six months. That makes them much more attractive than a 5-year TIPs with a return that is is 0.98% below the inflation rate. Zero is good. Negative 0.98 is bad.

The current I Bond interest rate – 3.06% – guarantees that you will receive a 1-year return of 1.53%, but probably higher, even if you sell after one year and pay a three-month interest rate penalty. If you sell after 5 years, there is no penalty.

While you could consider a 5-year CD if you can find an attractive rate, there really is no contest between this I Bond purchase and the 5-year TIPS reissue of Dec. 15. I Bonds are still the clear winner, even at a lower interest rate.

And if you have purchased I Bonds up to the limit in 2011, you can hold that investment for one month and buy them again in January 2012.

Posted in I Bond, Investing in TIPS, Savings Bond | 3 Comments