New I-Bond Fixed Rate Coming May 1

[moda0306]

LW,

I talked my dad into getting some and helped him, but that's it.  

I agree we're just getting our inflation back, but as long as it beats 1-3 year treasuries as consistantly as it does I'll be ok with it.  Often the "cost of having cash ultra-liquid" is losing a bit to inflation, but it still remains an important part of the PP, so I will simply take what I can get.  It seems to me that due to peoples' fears and the fed's pressure liquid cash is just insanely unattractive in return right now, but people still need it, period.  Other than my 5-year Ally cd, I-bonds are my favorite cash instrument, and with 3 year treasuries yielding just over 1% I think the PP would be too conservative for me if it weren't for my "cheats."  Cash is my least favorite PP asset for the fed-manipulation reason you mention, but I-bonds have consistently beaten not just MM but 1-3 year treasuries... usually hovering around the 5-year return rate.  I'm sure I'm speaking to the choir here but I'm just excited that there's something yielding more than 1% for an entire 25% of my portfolio.

One last thing... I tend to agree with MT that if we can't get a wage/price spiral going, these surges in commodity prices are going to be somewhat volatile back in the opposite direction at times.  It's nice to have a 6-month positive inflation adjustment and not be able to lose principal if it goes negative the next round in these times.

[moda0306]

Also... Grandmas indeed... I remember laughing at the idea of these ridiculous government bonds back in high school (2001-ish for me).  Now, the idea of having a year 2000 I-bond running along at 3.5% fixed is astounding to me.  Now with 0% fixed its tough but for the consistent inflation adjustments they make and the fact that nothing really competes historically unless you want to take FDIC risk or even more.

[moda0306]

To build on my skepticism of cash, I really could use a reminder (actually seeing it happen month-by-month) that years like 1981 do happen.  I don't think we'll see that play out that same way again, but the 3 volatile assets of the PP work so well on their own that it can be easy to start questioning your cash, especially if you are above-and-beyond your 3/6/12 (whatever maks you feel comfortable) emergency fund need with your cash portion of the PP.

At that point I find it very tempting to run a 3x33 PP + fixed portion emergency fund.  I know I shouldn't but it's so tempting to me still given how well the other assets work (most of the time).

[Lone Wolf]

Other than my 5-year Ally cd, I-bonds are my favorite cash instrument, and with 3 year treasuries yielding just over 1% I think the PP would be too conservative for me if it weren't for my "cheats."

Having safe, liquid cash at hand is a real plus of the portfolio, though.  The volatility dampening, safety from being "forced" to sell to raise cash, and ability to bargain-hunt in 1981-style scenarios are all great.  I agree that it really takes time to see cash as an "investment", though.  Picking the very best cash instruments is a great way to deaden the pain. 

If you add up the emergency fund and maxing all of the other wonderful little "tricks" like savings bonds, I bet that 25% isn't too far off from what most would have in cash anyway.

I doubt that keeping the cash arm "light" would be that terrible of a thing to do, but I don't see an especially compelling reason to mess with success.  I do track the 3x33 "super PP" on SmartMoney just for fun but I don't feel especially compelled to try it out for myself.

It's nice to have a 6-month positive inflation adjustment and not be able to lose principal if it goes negative the next round in these times.

Yes, huge point here.  TIPS do not do this because they only protect your principal over the course of their entire lifetime.  I-bonds, on the other hand, protect your principal at each 6-month "window".  If you see deflationary periods followed by inflationary surges, I-bonds are going to still make you some money even if TIPS would have earned you a final total of 0%.

[moda0306]

TIPS are just completely unappealing IMO.  I liken them to the Best Buy electronic upgrade program where they actually admit to electronics going obsolete quickly but mend that by entering you into what is I'm sure a form of indentured servitude for continuous electronic upgrades.

If the rates of return on treasuries weren't measly enough, try attaching an inflation protection mechanism to them.  Tadaaa!: TIPS.

[HB Reader]

I hope everyone realizes that during most of 1981-82, even two or three year CDs or Treasuries were considered to be dangerous because of their excessive "interest rate risk."  Of course, this was only after it had become apparent that Paul Volcker (appointed by Democratic President Jimmy Carter in late 1979) was serious about his announcement that he intended to squeeze the money supply and break the back of inflation.  The sea change in attitude in the markets occurred very quickly.  I even remember some Doonesbury cartoons during 1982 deriding (mocking, actually) some young and elderly investors for "abandoning" the real estate and stock markets in order to "score big" in the newly-created money market funds.  I have no idea whether this will ever happen again, but I say it only to remind people not to chase yield too much with their cash holdings.           

[Lone Wolf]

I hope everyone realizes that during most of 1981-82, even two or three year CDs or Treasuries were considered to be dangerous because of their excessive "interest rate risk."

Very interesting.  I'd honestly never known that this was the attitude of the time (I was too young) but it makes sense.  Thanks for the perspective.

Do you see I-bonds as having a significant interest rate risk?  They can be sold after one year at a penalty of only three months interest.  It seems to me that in an environment of rapidly rising rates you can just roll over into T-bills very quickly if conditions demand it.

This is a vulnerability that my 0-3 year Treasury ladder (or SHY) faces, though, so I take the risk seriously from that perspective.

[HB Reader]

Well, I'm holding some I-Bonds I purchased in 2000 and 2001 as a part of my cash reserve. But I wouldn't hold more than maybe 25-30% of my cash that way.  They are probably okay (especially given the lack of alternatives to straight T-bill holdings), but they haven't really been tested in a "Fed-forced" high interest-rate environment like 1981.

They are definitely superior to 2-5 year CDs, but IMHO safety dictates keeping most of your cash in very short term Treasuries or Treasury money market funds (if you can find one that is open).  If you can't stomach the low yield on actual T-bills, SHV (or possibly SHY) may be okay if you buy them with low enough commissions.  It's a tough environment.  

   

[AdamA]

They are probably okay (especially given the lack of alternatives to straight T-bill holdings), but they haven't really been tested in a "Fed-forced" high interest-rate environment like 1981.

You're saying that in a high interest rate environment, six months may turn out to be too long to keep up with inflation vs. what shorter term T-bills may be able to do, right?

[moda0306]

I'd say that 1-3 year treasuries proved to keep up with rates pretty well in the 70's but your point is well taken.  I think most people keep a relatively high amount of super-st cash before they start dipping into 1-3 year bonds.

I-bonds, on the other hand, with their 6-month rate change schedule but 1 year minimum hold time seem to be a safer option, especially as they historically return better than 1-3 year treasuries at any given time.  I don't see there being much risk as long as people have plenty perfect cash before dipping into 1-3's and I-bonds.

HB Reader, so how awesome is it to be holding I-bonds issued in 2000?  I'd imagine those are pretty nice to be holding right now.  Nice foresight on that.

[moda0306]

I will admit, with years like 1981 being the PP's achilles heel (if it even has one), it does make the case for shortening your duration... it just seems like the yield curve almost always rewards you for going a little longer in duration, so it's tough for cash-averse people to swallow those measly MM returns.

It will be interesting to see if the yield curve ever in the future goes hard in the other direction (ST rates significantly higher than LT rates).  I just don't see that in our current environment.

[HB Reader]

Yeah, buying I-Bonds in 2000-2001 was one of my better decisions.  At the time, I remember thinking "Wow! 3.4% over the rate of inflation for 30 years.  This is the closest thing to a free lunch I've ever seen.  What's the catch?"

But it really wasn't so obvious at the time.  I-Bonds were pretty new (I think they had been introduced about 1997 or 1998) and tech stocks, like Cisco Systems and Global Crossing, were all the rage.  I was just fortunate to be at a point in my career (and marriage finances) to take advantage of the opportunity to buy my limit.

In 2003, I was told by someone retiring from the Treasury Department that Larry Summers had pushed to have I-Bond rates as high as possible in 1999 and 2000 because the Department really wanted to make sure they would "catch on" with the public.       

[HB Reader]

They are probably okay (especially given the lack of alternatives to straight T-bill holdings), but they haven't really been tested in a "Fed-forced" high interest-rate environment like 1981.

You're saying that in a high interest rate environment, six months may turn out to be too long to keep up with inflation vs. what shorter term T-bills may be able to do, right?

Sort of.  It just seemed at the time that whenever you looked at rates -- short or long term -- they were higher.  Press predictions were that inflation and interest rates -- especially long rates -- could only go up.  In other words, you hated to lock up money for any length of time.  In hindsight, a ladder would have worked out okay for some of your cash reserve if you had been very disciplined and stuck to it, but it sure seemed like a fool's bet for a couple of years.  Even though I was pretty well versed in economic history (I thought), even a a few years later it wasn't entirely clear that interest rates in 1980-82 had been an anomaly. 

[moda0306]

I can't imagine rates getting much more out of control than in the 1970's-early 80's, so if the 1-3's performed that well during that time, I can't imagine 6 month - 1 year holdings (I-bonds) would have been that dangerous.

If the kind of inflation occurred where you were scared to lock up for even 6 months, I'm sure hoping my gold is doing more than its fair share for my portfolio at that point.

[HB Reader]

They really weren't out of control.  The Volcker Fed had simply decided in October 1979 that inflation had to be stopped.  If it took 16% T-bill rates or 14% thirty year bonds, so be it.  I-Bonds and TIPs did not exist.  If they had, I-Bond rates (tied to the CPI) would probably have come down before general interest rates because of the Fed's determination to keep interest rates high to wring inflation out of the system.

I'm certainly not trying to trash I-Bonds.  The point I was trying to make was that while you're in the midst of that happening, you simply don't know at any particular time if inflation and interest rates will continue to go up, drop dramatically, fluctuate widely or decouple completely.  In fact, there was a "double dip" recession between 1980 and 1982.  There was also some fear that something like 2008 would occur as a result of prolonged strain in the system.  In the midst of that kind of environment, the natural reaction is to keep your powder dry by staying with very short maturities.     

[AgAuMoney]

Still 0% fixed, but look at that inflation factor.  2.3% for 6 months resulting in a 4.6% annual rate

That's more than 30 year treasuries, with no interest rate risk and no default risk.

And never a cap gain "pop" because there is no secondary market.

And only for 6 months (rate can change every 6 months, anywhere from 0+ on up to the CPI).

And you cannot sell for 1 year (but can buy at the end of the month and sell at the first of the 13th month for an 11month + a day or two holding period).

I Bonds fit in as part of the cash position, not as part of the LTT position.  Just watch out for the mandatory 1 year hold.

[AgAuMoney]

Negative inflation-portion interest can't eat into your principal... but can it eat into a previous-period's inflation portion interest?  I'd imagine that amount counts as principal at that point and it can't retroactively go back and steal previously calculated interest.

Correct.  Interest is credited every month (but you won't see it until 3 months delayed for the first year) and will never be taken away.  Worst case is you earn 0% for however long inflation is negative.

[AgAuMoney]

Does the Inflation portion come out tomorrow too?

I assume it does.  It looks like that number is already available.

Yes, the inflation portion was available mid-april when the BLS released the CPI-U number for March.  I calculate it myself from the CPI-U, because I don't think the treasury publishes it until 1 may.  (same idea for the fall, just six months later).

Just updated:  http://spreadsheets.google.com/ccc?key= ... sQkE&hl=en

[MediumTex]

I Bonds fit in as part of the cash position, not as part of the LTT position.

Sorry if I wasn't clear on that one.  The point I was getting at is that Ibonds currently allow you to get a yield that would otherwise require you to go much farther out on the treasury yield curve without having to take on any of the associated interest rate risk.

Ibonds are definitely for the cash piece of the PP, not the long term bond piece and not the gold piece.  Normally, people are tempted to use Ibonds or TIPS for the gold piece, which is a terrible idea (as we have explored in great detail in prior discussions). 

[moda0306]

My wife is going back to school to get her masters... this might just be the perfect storm to get me to plunk some money down for an i-bond w/ some of my cash and get the best guaranteed, tax-free return one could imagine.

AgAuMoney, I'm assuming early redemption (less than 5-years) due to education costs doesn't protect you from the 3-month interest penalty, does it?

[AgAuMoney]

AgAuMoney, I'm assuming early redemption (less than 5-years) due to education costs doesn't protect you from the 3-month interest penalty, does it?

That is correct to my understanding, but I've not done anything yet with iBonds and education.  Supposedly using an iBond for education expenses can be tax free but I haven't figured that part out yet.

[walkerjks]

AgAuMoney, I'm assuming early redemption (less than 5-years) due to education costs doesn't protect you from the 3-month interest penalty, does it?

That is correct to my understanding, but I've not done anything yet with iBonds and education.  Supposedly using an iBond for education expenses can be tax free but I haven't figured that part out yet.

Check out http://www.treasurydirect.gov/indiv/pla ... cation.htm for details.  Income limits do apply.

[moda0306]

Thanks Walker.  Those are relatively low limits and it's good for people (not me... still not hitting most phase-outs) should see that and be aware.

[moda0306]

I kind of think of I-bonds as a middle-class handout, but after thinking about the implications of a 40-year old with 6 or 7 digit income, he and his wife could have $200,000 in i-bonds over a 10-year period.... and that doesn't count any compound interest.

Not bad if you get started early.

[Gumby]

So, what are people thinking here? Buy our 2011 I-Bonds now, or wait until November to see if rates go up?