I bonds, the ugly


J

johnrichardson_us

After reading _Worry Free Investing_, I took a serious look at I
bonds. I didn't really like what I saw.

It seems that I bonds have a pathetic real return. After tax they
have a .29% return for the 25% bracket, at least for now. The 1%
fixed I bonds are just about 0% real after tax. For comparison, in
the same tax bracket, money markets are at about .5% real after tax.

Bernstein suggested I bonds might have a negative real return, and for
the higher tax brackets that does appear to be the case.

According to my simplistic calculations, if the inflation rate equals
(fixedrate * taxbracket) / (1 - taxbracket)
then return will be zero real. In inflation is more then you'll lose
money in real terms. For the 25% bracket, the fixed break-even point
for 3.1% inflation is just about 1%. If inflation is at 3.5% (the
historical US average?) the fixed rate has to be about 1.17% to break
even in real terms. Etc...

This all got me to thinking. Perhaps a better way to keep real
returns would be to use 90 day t-bills? Theoretically, they won't
sell unless the yield negates inflation and includes a positive return
after tax. Perhaps this doesn't work in practice?

In any case, it doesn't seem like I bonds are the "better cash" I
thought they might be.

Perhaps we just have to wait until the inverted yield curve corrects?
 
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Z

zxcvbob

This all got me to thinking. Perhaps a better way to keep real
returns would be to use 90 day t-bills? Theoretically, they won't
sell unless the yield negates inflation and includes a positive return
after tax. Perhaps this doesn't work in practice?

In any case, it doesn't seem like I bonds are the "better cash" I
thought they might be.

Perhaps we just have to wait until the inverted yield curve corrects?

Right now, 28-day T-bills are paying more than 90-day. My daughter
purchased two T-bills last week, the 28-day got 5.2-something percent,
and the 90 day was 5.1-something -- a difference of .14 (.14 is quite a lot)

Bob
 
D

darkness39

After reading _Worry Free Investing_, I took a serious look at I
bonds. I didn't really like what I saw.

It seems that I bonds have a pathetic real return. After tax they
have a .29% return for the 25% bracket, at least for now. The 1%
fixed I bonds are just about 0% real after tax. For comparison, in
the same tax bracket, money markets are at about .5% real after tax.
My limited understanding is that they are best thought of as a form of
near-cash, with correspondingly low return.
This all got me to thinking. Perhaps a better way to keep real
returns would be to use 90 day t-bills? Theoretically, they won't
sell unless the yield negates inflation and includes a positive return
after tax. Perhaps this doesn't work in practice?
See below. Fed monetary policy gets in the way, for short maturities.
In any case, it doesn't seem like I bonds are the "better cash" I
thought they might be.

Perhaps we just have to wait until the inverted yield curve corrects?
I don't know enough about I Bonds, but I think your logic is in
general good.

As has been suggested here in another thread, 2 year US treasury bonds
mostly free you from the effects of short term Federal Reserve
policy. When the economy slumps, the Fed tends to drop interest rates
to sub inflation levels, to try to restart the economy.

Also when you have a normal sloped yield curve, by buying 1-5 years
out, you 'ride the curve' (getting a higher yield than T Bills).
 
J

joetaxpayer

Mark said:
Look at historical figures. You don't have to go back too far, just to
before the Fed started tightening. For example, here's a page from mid-2004
(June 29th) by Hulbert quoting the 90-day Treasury yield as 1.36%.
http://www.marketwatch.com/News/Story/Story.aspx?guid={B5C4182F-801E-473D-9DCC-7416A8CAE102}

Forget taxes. That doesn't even make up for half the inflation rate, which
was 3.27% in June 2004, and 2.68% over the whole year.
http://inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx
? John posted that for an inflation rate of 3%, it would take a real
rate of 1% to offset a tax rate of 25%. In other words, a 'real' rate of
1% is actually zero. And if some higher rates returned, the 'inflation
protection' is somewhat specious.
There was talk sometime back of indexing cap gains to remove the
inflation component. I'll concede that the math and tracking would be
cumbersome, but a good first step would be for an iBond whose inflation
component was a non-taxed return.
JOE
 
M

Mark Freeland

joetaxpayer said:
Mark said:
(June 29th [2004]) by Hulbert quoting the 90-day Treasury yield as 1.36%.
[...] Forget taxes. That doesn't even make up for half the inflation
rate, which was 3.27% in June 2004, and 2.68% over the whole year.
? John posted that for an inflation rate of 3%, it would take a real rate
of 1% to offset a tax rate of 25%. In other words, a 'real' rate of 1% is
actually zero.
That's a 1.36% nominal yield, which is why you have to compare it to
inflation. If it didn't beat inflation (3.27%) before taking out taxes, it
certainly didn't beat inflation after taxes!

He was speculating whether T-bills (with their non-inflation-adjusted rates)
give positive real returns:

;; Theoretically, [90 day t-bills] won't sell unless the yield negates
inflation
;; and includes a positive return after tax.

My point was that even without subtracting off taxes, it's easy to find
periods in which T-bills don't match inflation, much less exceed it (so
that their pre-tax, real return is negative). Therefore, any theory that
postulates that T-bills' selling price must always give positive real
returns is contradicted by experience.

Mark Freeland
(e-mail address removed)
 
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B

Bucky

On Mar 12, 9:27 am, "(e-mail address removed)"
It seems that I bonds have a pathetic real return.
Currently maybe. But what if you had bought i-bonds back around 2000,
when the fixed rate was a whopping 3.6%
 
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