About those five-year CD ladders-- I bonds?

[Nords]

Father-in-law and I were fixing the stock market last night in between fireworks shows, and we realized that a ladder of five-year CDs might not compete with a ladder of I bonds. It depends on tax brackets, auction prices, & inflation rates.

I bonds have to be held for five years or longer before redemption to avoid a three-month loss of interest (although they can still be redeemed earlier if you're willing to suffer those consequences). And maybe they're worth holding on to if new auctions are lower.

I bond investors are limited to annual buys of $30K of I bonds in paper and another $30K on Treasury Direct for each Social Security number. So a married couple needing more than $60K I bonds each year would end up shuffling paper, and at more than $120K they'd have to seek other options.

CDs aren't protected against inflation, although hopefully five years isn't too long a period to get savaged by rising rates. Unlike I bonds, 5-year CDs expire at five years without extension. A five-year CD ladder would have only $20K/year before exceeding FDIC or NCUA insurance limits (unless split among joint & spouse accounts). And CDs have their own harsh early-redemption penalties.

NFCU is now paying 4.5% before taxes on a 5-year $20K CD. In our 15% tax bracket that's 3.8% after-tax (no state taxes). In the 25% bracket (for us IRA converters) it would be 3.38%. I bonds are at 3.39% through Oct 04 with an inflation-hedge kicker.

Any other thoughts on these musings?

 

[cute fuzzy bunny]

Yes.

#1: thanks for fixing the stock market. I've been meaning to get to it but I've been busy lately supplying the missus with meals every 2 hours to combat the morning sickness. Which thankfully appears to be subsiding. As a side note, for anyone else who is or becomes afflicted with a pregnancy, a tea made from a gallon of water simmered with a big chunk of fresh ginger (chopped) and a few cups of mint, then filtered, was a big hit for settling the nausea.

#2: wouldnt it be a good idea to wait a quarter or two (before the end of the year though) to buy this years allocations of tips and ibonds? Rates just bumped .25 and they'll likely bump another .25-.5 before the end of the year...wont you get a better rate for that 5 year+ period by waiting a little bit?

I suppose I should go and buy some individual bonds but I never have. Just funds. I understand the mechanics but hear horror stories from people who make a small mistake and get their ass handed back to them.

 

[Roger_R]

I suppose if it isn't already said, you really don't have to cash in I bonds for 30 years. Where as the CD's are defined. I suppose you might actually get lucky and find out at five years that you might be beating the going rates and hang onto them.

 

[sgeeeee]

I've always liked I-bonds as a part of my bond ladder. I liked them more when the yields were higher, but I still think it's a pretty good idea to own some for my bond ladder.

I think inflation is likely to come on in a big way sometime in the next several years. If it does, I-bonds and TIPS will look much better than CDs. If not, they may not look quite as good . . . but they won't look awful.

Also, I-bonds give me some versatility that CD's don't offer. I'm only estimating how much I'm going to need to spend each year for the next 5 years with my bond ladder. I might spend less than that and the I-bonds provide a nice way to take up the slack. I don't have to turn them into cash in 5 years. In fact, if inflation runs up for an extended period of time, it may make sense to keep the I-bonds and cash in some other investments. On the other hand, they could be converted into cash after only a year if I was desperate -- and the hit I take if I needed to do that is probably more palatable than whatever dire situation would cause me to do it.

I am trying to keep my bond ladder built from a mix of Government, Agency and Corporate bonds (even a small component of junk). The percentage of each bond type varies from year to year depending on what looks like a good buy to me, but I like including some I-bonds. This year I'm waiting till November to add that component to the ladder.

 

[sgeeeee]

Oh . . . Nords,

I also meant to thank you for your efforts to fix the stock market.   Do you do this on a voluntary basis or is this part of a secret job you have?  

 

[cute fuzzy bunny]

It was pretty good actually. Put a little sugar in it and it tasted like flat really spicy ginger ale.

The ginger tea I mean, not the ibonds.

Wonder what those would taste like with a little hot sauce on them.

 

[John Galt]

I made a major switch about a year ago from CDs
to bonds. I could no longer accept the CD rates.
Now, I have a whole hodge-podge of bonds, notes,
bond funds, etc. If NAV fluctuations were an issue
I would not have made the switch. But, for me., this
is forever money. As long as it throws off the current
income, the NAV is sort of moot. Would I prefer an
NAV increase? You bet! But, I need income! Currently
I get at least 5% on everything. I can live with that.

John Galt