Comments on: Savings Bond Alert #027

by: Adan Lerma

Sat, 20 Jan 2007 01:01:57 +0000

I think that's what I've wanted to figure out, what would happen in a deflationary environment. And if I decided to sell, after a period of negative inflation, my I-bonds (after a yr) I could sell w/out paying a commission and know I'd get my full initial amt. With a TIPS, I could sell right away (but probably wouldn't have just bought if deflation were really a near possibility) but only by paying a commission, even via Treasury Direct, and, if in a deflationary climate, probably receive less than my starting amt. There. Thank you for helping me figure out what I was trying to decide about. Tom, please keep up the great info.

by: Tom Adams

Fri, 19 Jan 2007 15:54:07 +0000

Adan - if deflation were to occur, I bonds would outperform TIPS because the value of I bonds can't go down, while the value of TIPS can. The I bond interest rate can't go below zero, but it can be zero if a negative inflation component wipes out the base rate. In deflationary times, obviously, EE bonds and other fixed-rate securities would outperform inflation-protected securities.

Joe - today Bankrate.com is showing 1- to 5-year CD rates in the 4.75% area (this is a national average), so if you got 6% that's a good deal, particularly if you got it for five years rather than six months or something short-term like that.

by: joe

Fri, 19 Jan 2007 03:28:15 +0000

I've redeemed all my bonds with the exception of the 1999 and 2000 I Bonds (with fixed rate of 3.4 and 3.6 percent) and reinvested them in CDs paying 6% or more. Even with fixed rate of 3.4-3.6%, the I bonds are paying no more than the CDs right now, and may pay just 3.4-3.6% when inflation rate drops to zero, which will further reduce the bonds' attractiveness in comparison with other savings instruments.

by: Adan Lerma

Fri, 19 Jan 2007 03:15:01 +0000

Tom, thanks for the response. I'm still trying to learn as much as I can, and one never knows what wrinkle might be missed, so thanks for the info.

I think what I also don't like about TIPS (right now, at my stage of learning) is even if the inflation component is small, with the I-bond, it'll still earn interest on a non-reduced principle, while with the TIPS, if the principle's been reduced, less interest is earned. So I'm not even sure there'd necessarily be a full 1% difference at maturity or redemption. And that's not factoring in the tax deferment of the I-bond, or does it?

Anyway, the other question, from Svenson, is really interesting. Is it really possible there'd be a zero interest rate? It could be negative could it, at least with the I-bond, since the accumulated principle can't be reduced? Or would $ be subtracted from prior $ earned and accumulating, even if deferred?

Thanks for the great book (old edition and all the updates, really invaluable.

Adan

by: Tom Adams

Thu, 18 Jan 2007 20:37:10 +0000

Adan - If held to maturity, the main differences between TIPS and I bonds is that TIPS pay about 1 percentage point more, the TIPS inflation adjustments happen monthly, and you pay income tax on both the interest and the inflation adjustments annually. If you redeem TIPS early you can have capital gains or losses (related to changes in the general level of interest rates); with I bonds there are no capital gains or losses. None of this has changed, so I don't think the relative desirability of TIPS and I bonds has changed, either.

Svenson - Yes, this is an interesting possibility. If new investments are low now, imagine what they'd be like with an introductory six-month I bond of 0.00%

by: Svenson

Thu, 18 Jan 2007 20:11:53 +0000

We've never had a negative I rate before. I wonder what fixed component will be offered if the inflation component is negative. Couldn't this be a setup for some rewarding fixed components?