I-Bonds Discussion Thread (continuation of the FW thread)

Finance
402

I bonds are already up to 3.3% annualized for the next period and that’s with 4 months to go. At this rate, we’ll get 10% annualized for the next block, but I don’t think it’ll come in quite that high.

For I Bonds. The May number is the second in a six-month string that will determine the I Bond’s new variable rate, which will be reset on November 1 based on inflation from March to September. So far, just two months into this rate-setting period, the I Bond would get a variable rate of 3.34%. Since four months remain, a lot will change before the November reset.

  • BREAKEVEN INFLATION RATES ON FIVE-YEAR TIPS RISE TO 3.14%, HIGHEST SINCE MAY 18

On the subject of TIPS, I saw this good comment elsewhere, which cast a bit of doubt on the role of TIPS in protecting against inflation.

Bad yields and bad taxes -

In terms of yield, TIPS are actually the worst instruments to hold. This is because the way they work is that, say, a Treasury bond is issued at a 3% coupon at the same time that inflation is expected to average around 3%. What will happen is that the TIPS coupon will be set at right around zero (the latest 10Y TIPS auction I’ve seen had a coupon of 0.125%). And the way the inflation bit works is that the principal gets adjusted upward based on the move in CPI. So if inflation is 8% then your coupon in effect increases from 0.125% to 0.135% from the principal multipliers. I guess that’s something but it’s a long way to 8%. What’s worse is that the uplift to the principal is treated as currently taxable income (even though you don’t get that principal uplift for 10 years)…

And lots of interest rate risk too, confounded with your inflation protection can lead to losses -

The other thing to keep in mind is that TIPS don’t always give you the performance of inflation. For example, inflation has been running around 7-8% year-on-year. What would you guess is the performance of the iShares TIPS Bond ETF year-to-date? Well, it’s 8.5% except with a minus sign in front of it. WTF? Well, just like nominal Treasuries are a function of nominal Treasury yields (or the other way around if you prefer), TIPS are a function of real yields. 10Y real yields have increased from -0.5% to +0.7% year-to-date and higher yields are bad for bonds and TIPS are bonds. Specifically, they are bonds with a long duration so they are down. Real yields are much more reasonable now so I don’t expect TIPS bonds to keep dropping if inflation stays here but they aren’t the usual slam dunk in a period of high inflation – you need to look at the starting point of real yields too.

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The discussion you quote is garbled and I cannot understand it. Here’s a discussion of how tips work:

To illustrate, assume a $1,000 U.S. TIPS was purchased with a 3% coupon; also assume inflation during the first year was 10%. If this were the case, the face value of the TIPS would adjust upward by 10%, to $1,100. Furthermore, the coupon payment (3%), which is also based on face value, would be $33 (payments adjust and are paid semi-annually). The result is that not only are interest payments protected against inflation, but so is the bond’s face value, which is returned to the investor at maturity. Traditional nominal bonds offer neither of these protections.

xerty, please explain the problem you have with this.

The source for the quote above

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It is true that the inflation adjustment is taxed every year even though you only receive the amount at maturity or when you sell the bond. you can get around this by holding the tips in a tax deferred account like an IRA. you still have to pay the tax when you withdraw from the IRA but it’s a push from federal tax since it’s taxable anyway. With the IRA you do have to pay state tax on the withdrawal, which you do not have to pay if the tips is in a taxable account. so pay the tax from other funds or sell some bonds to pay for the tax,

by the way, I do not argue that tips are better than iBonds. they are not, but the amount that you can purchase is unlimited.

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You’re both right. The point they were making is that if you want cashflow / yield, you don’t get (much) of that from TIPS. The actual annual payments on the 3% TIP from your quote start at $30/year on $1000 face and, after 10% inflation, rise to $33/year on a $1100 face. So your 3% yield rose to a 3.3% yield on your original investment (=$33/$1000) and you can’t spend that to offset 10% higher costs. Of course you can sell the 10% appreciated principle part by selling a fraction of your TIP holding.

I bonds in contrast pay a higher yield based off of (somewhat delayed) recent inflation, so if inflation is 10% for a while, 6-12 months from now that shows up in your I bond yield. But I bonds are zero coupon so you don’t get paid along the way and have to sell them in a similar way to TIPS if you want to realize higher personal cashflow to offset higher costs.

Both do protect you from inflation in that they lock in a fixed real rate of return at the time of purchase. “Yield” is kind of a dumb metric anyway. It’s like caring whether your stock pays you by dividends (yield, like I bonds) or via capital appreciation and a rising value (TIPS, principle adjustment). Either way you have more money and you can sell some of the asset to spend those gains if you want.

The bigger point I thought worth highlighting was the bad performance of TIPS over the last year. This is due to their interest rate risk and long maturity. Like any bond whose properties are fixed when created, you lock in a YTM (or for a TIP, a real inflation protected yield) based off the bond’s coupon and the price you pay when you buy. If interest rates, or real rates, move higher, your bond is less attractive and falls in price. This is why TIPS funds did badly - those who bought a year about at real rates of -0.5% were wrong in their market timing and real rates are now positive and rising. Their old purchase fell in value to make them comparable to the current yields offered in the market. But you still get your -0.5% inflation protected real yield from that old purchase, it just isn’t so hot compared to what you could have gotten if you waited in cash and inflation and the Fed moved more than people expected.

Here you can see the 1 year performance of some bond and TIPS ETFs. Interest isn’t included, but it gives you the right idea (and yields are low anyway).

VTIP - short term tips (0-5 yrs)
TIP - medium term tips (5-10)
LPTZ - long term tips (15+)
BND - medium term bonds
TLT - long term bonds

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They all lost money in nominal terms, and as rates rose, longer term bonds lost more and shorter ones lost less.

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406

As you mentioned, this is true for any long term bond. see below. With TIPS, you do get the large 2022 inflation adjustment to ease the drop in value.

Vanguard Total Bond Market Index (VBTLX) Performance

Fund Performance . The fund has returned -8.65 percent over the past year, 0.36 percent over the past three years, 1.17 percent over the past five years and 1.68 percent over the past decade

[iShares TIPS Bond ETF (TIP) Performance History - Yahoo Finance]

Performance Overview -6.07% YTD Daily Total Return -1.77% 1-Year Daily Total Return 4.06

Edit. I see that you were completing your post as I wrote.

The bond fund aficionados on the Bogleheads will argue that if you reinvest the interest for the duration of the bond fund, the performance will will reflect the performance of an individual bond of the duration.

with no risk treasury securities, I prefer to hold individual bonds to maturity.

but when there’s a sudden jump in interest rates as in this year, any holders of longer-term bonds are going to get hurt. Regardless of whether they’re tips or not

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407

Yeah, here’s an inflation adjusted treasury yield chart that shows how buying TIPS last year was bad market timing since real yields have risen from -1.6% to basically flat for a 5 year term.

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And a closer look at the last month or so

image

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408

The real yields on tips have come off zero:0.5% for five year and about 1% for 10 year. As of June 14, 2022.

Here’s a pretty fair comparison of I bonds versus tips. See the graph of the after tax return for the 30 year Tips with 1% real yield. You lose money in real terms with both just not as much with the tips

image

Edit. Again, I think you should buy your allotment of iBonds every year. But as I’ve said before, the jumping through hoops to increase it beyond $10,000 is not worth it to me

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409

In the long term, maybe TIPS and I bonds aren’t that different - after all their real yields are similar. Sure the I bond pays 1 year of higher rates if you time it right, but that premium amortized over 30 years or even 10 years is pretty small.

I bonds are best for 1-2 year holds IMO, where the structure of lagging payoffs can be meaningful and you retain the option of switching to TIPS if their real yields are much better.

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Isnt the primary difference the fact you can get out of I Bonds clean, especially after 5 years, while with TIPS you are at the mercy of the market for anything less than the full bond term?

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411

What I continue to like about I bonds, which is not at all a feature with TIPS, is the tax aspect.

With my I bonds I “buy 'em and forget 'em”. At my age I never will have to pay the tax. And more important, my I bonds do not screw me over on the hated IRMAA. You cannot beat I bonds when they are viewed through the taxation lens.

TIPS: you gotta report every year. Sucks.

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As you know but I will mention it, you cannot get out of Ibonds in the first year and you have to pay a penalty up to five years. Also as of today, five-year tips have a 0.5% real rate which makes a large difference compared to the zero real rate of iBonds as shown by the article linked in my post.

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413

Yes, tips should be held in tax deferred accounts. But this makes a real difference in simplicity as you do not have to have a separate treasury direct account.

With either iBonds or tips you have to pay tax on the interest and inflation adjustment.

On the topic of accounts, there is a long thread on the Bogleheads of someone worried about himself or his heirs being able to access the treasury direct account as he gets older. The treasury direct website is very poorly designed in my opinion and hard for even people who are familiar with it to navigate and utilize.

With tips, you can hold them in your brokerage account and with companies like Fidelity and Schwab and others you have local offices that can help you.,

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414

As I mentioned, as of today, tips have a higher real rate than iBonds. The graph in my post shows it makes a fairly large difference in the after tax return.

Edit.
I hit the three response limit so here’s another article comparing I bonds and tips.

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Thanks for the various updates @onenote. You’re right that TIPS are now showing decent positive yields as of the last week or two. You can see the current yields here

https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_real_yield_curve&field_tdr_date_value_month=202206

Date 5 YR 7 YR 10 YR 20 YR 30 YR
06/17/2022 0.54 0.60 0.67 0.79 0.85

The yields have been quite volatile, especially for example on the 5 year TIPS - as low as slightly negative the first week of June, and at one point nearly +0.75% last week, and now around 0.5% roughly. let’s look at the merits vs the I bonds. From your last article linked,

Historically, I Bonds had have a real yield lower than a typical TIPS, and that is OK because I Bonds have several advantages: 1) a flexible maturity of 1 year to 30 years, 2) tax-deferred interest, and 3) much better protection against deflation.

The 5 year breakeven inflation rate is around 3%.

So if we’re going to compare a hypothetical 5 year I bond hold (no penalty) to a 5 year TIPS bought now, how should we think about their relative value? The I bond with a 0% base rate will pay 0.5% less per year than the TIPS, or 2.5% over the 5 year comparison. In contrast, the I bond bought recently before the May cutoff will pay roughly 8.5% average for the first year for sure, and then the same inflation for the next 2-5 years that the TIPS will get in years 1-4. In contrast, the TIPS will get the last year of actual inflation +0.5% base in year 5, while the I bond will get 8.5% in year 1. Given we’re looking at breakeven 5 year inflation rates, that suggests that the last year TIPS yield is likely to be no more than 3.5% (3% inflation + base; could be lower since the breakeven inflation is the average and everyone knows the inflation is higher now than that, so the average requires the end be lower than the average). So that’s a 5% differential, 8.5% vs 3.5%, in favor of the I bond due to the “buying high past inflation” effect when one expects future inflation to be lower. That makes a bigger difference than the 2.5% cumulative 5 year base yield difference. The Forbes article I believe omits this effect.

The longer you plan to hold, the more the 0.5% base rate difference in TIPS matters, and the base rate is higher for longer maturity TIPS so you should use those if you’re planning to hold 10 years, etc.

Besides the favorable relative tax treatment, I bonds have great optionality which TIPS do not. First, if there’s deflation, I bonds don’t lose money and just earn 0%, while TIPS lose at the deflation rate. That’s worth something, but I’m not a good enough fixed income options trader to figure out what the market rate would be for buying deflation options to protect your 5 year TIPS against those losses. It’s worth something, but I don’t think deflation is super likely, so probably not much especially for shorter maturities.

Second, you have a cheap option, in the form of the 3 month penalty, of switching to something else when rate conditions no longer favor the I bond, while the TIPS has a market price which means if rate conditions are unfavorable you’ve already lost that money by the price falling. For example, let’s say during a typical time later in the 5 year I bond case, we have inflation around 4%. If we want to switch out of I bonds, that will cost us 1% for 1/4 of the recent 4% annual yield. If this was at the 3 year point, we could compare that to a TIPS yield and see if that penalty was worth the swap. If real rates were now 1.5% on TIPS instead of 0.5%, we could pay the 1% penalty and then earn 1.5% more than our 0% base for 2 years and come out with 3% extra base rate earnings - 1% penalty, or 2% more money. This option is quite valuable I think, and especially if you’re considering 10 year TIPS or longer when swapping to a higher TIPS rate is worth more due to the longer time to maturity if the real rates become more attractive earlier in your relatively long holding period (and the option becomes free after 5 years).

If you run the same numbers of say a 10 year TIPS, you have a 0.67% base, so the TIPS earns an extra 6.7% over 10 years and a 3.3% last year (2.6% 10 year breakeven plus 0.7% base), vs the I bond getting 8.5% for the first year. So that’s 5.2% in favor of the I bond vs 6.7% in favor of the TIPS, so a net 1.5% total gain for the TIPS or 0.15% annual advantage. Against that, you’d need to weigh the tax benefits and the optionality I cited above. I’d still probably pick the I bond, but it gets less clear the longer you intended to hold you TIPS.

In short, I would still buy I bonds over 5 year TIPS at current rates, and hopefully these examples lay out why. Longer term TIPS are more competitive. If I’ve missed something, please let me know.

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416

You will get no argument from me that iBonds have an advantage over TIPs. But as I mentioned in my posts, what do you do if you want to invest more than $10,000 a year?

Yes you can fool around with income tax refunds, trust accounts, etc. but that adds to the possibility of a problem. For example if the paper I bonds you get for a tax refund get lost in the mail? Both the IRS and treasury direct are almost impossible to get to by phone. You are left hoping that your congressman can help you out.

So for larger amounts that you want to invest in bonds you are left with a choice between nominal i.e. not indexed bonds and TIPS. For five year bonds, the breakeven inflation (nominal interest 3.3% - TIPS real 0.5%) is 2.8% as of June 19. I think the SHTF and we are going to have inflation much higher than that so I am buying TIPS in my IRA. Other investors may not but that’s what makes a market.

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

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The fixed rate on today’s five year tips auction came out to 0.362%. About 14 basis points below the 0.5% fixed rate of a few days ago. It is not directly comparable but comparing that to the zero fixed rate of Ibonds, that’s an additional $36 a year interest on 10,000 face value.

But the inflation adjustment on both of them will be about 8% or $800 on 10,000 face value.

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Two months later and I’m in on that trust account. Combination of ID form and incorrect trust registration.

It must be pretty bad. A Wall Street Journal reporter contacted me about doing an article on their backlog.

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TravelerMSY, did they tell you why you failed the identity check for your trust account? Was it because of an incorrect trust registration? What did you get wrong? Do they actually check your trust documents when they verify your ID during account opening?

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It was both and I don’t think they were necessarily related.

I seemingly followed the instructions on how to title it, but they didn’t like it. I was able to email them a copy of the trust at that point.

I assume if you have the trust titled exactly right they won’t ever need to see it.

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For mine, they revised it to… “TravelerMSY Trustee udt dated April 26, 2022 Louisiana Revocable Living Trust”

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