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Difference between I Bonds and TIPS??
Old 08-25-2003, 01:50 PM   #1
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Difference between I Bonds and TIPS??

Can some savvy person tell me what the difference is, if any?
I'm doing I-bond ladders now with extra cash because I can buy with credit card and get miles (till end of December).
Then would I be better off switching to TIPS, or is it basically the same?
Also, I have some old 6% savings bonds about to mature. Will they continue to grow at 6% after the date of maturity (next year), or do they go to some new way of computation?
Thanks, thirdage
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Re: Difference between I Bonds and TIPS??
Old 08-25-2003, 03:08 PM   #2
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Re: Difference between I Bonds and TIPS??

I will defer to someone else on your excellent questions,
except to say that for me, free miles are irrelevant.
I no longer fly and never will again. A nonflyer for about 20 years. Don't miss it a bit.
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Re: Difference between I Bonds and TIPS??
Old 08-25-2003, 03:26 PM   #3
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Re: Difference between I Bonds and TIPS??

Can't say I blame you; flying is not terribly pleasant. But I am one of those who feels imprisoned in a car for more than a few hours. I once bicycled from Miami to North Carolina and loved the experience. Absent the time that bicycling takes, flying free is better than flying and paying. I have gone to Argentina 5 times on free flights, and that is a significant savings. I say miles are not to be sneezed at!
Thanks for your post.
thirdage
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Re: Difference between I Bonds and TIPS??
Old 08-25-2003, 07:01 PM   #4
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Re: Difference between I Bonds and TIPS??

Quote:
Then would I be better off switching to TIPS, or is it basically the same?
Also, I have some old 6% savings bonds about to mature. Will they continue to grow at 6% after the date of maturity (next year), or do they go to some new way of computation?
Thanks, thirdage
Hi Third Age,

TIPs and I-Bonds are very different. They both offer inflaion protection, but there are several differences. TIPs are taxable in the current year, as to interest, and I believe as to stepped up value (inflation adjustment). So, if they are held outside a retirement account, you wind up paying income tax on book gains, with no offsetting cash to help you pay the bill. If your income is below the taxable level that would not be a problem.

Also, while TIPS guarantee that that they will be redeemed at least at face value at maturity, prior to maturity if you want to sell them, and if the country has been in a deflationary environment rather than inflation or stable prices, you could lose money. Similary, if real interest rates should rise, the real coupon on your tips would be worth less, and they could go down in value, relative to their theoretical inflation adjusted value.

Several years ago I bought TIPs with a core, non-adjusted yield of 3.4%. And a year or so prior to that, they sold with a core coupon of 4%. That may never happen again, but still it does demonstrate that the value of these bonds is subject to market forces.

I-Bonds, on the other hand lock in a value every 6 months. Afterwards, they will not fall below this value. So for example, if some time you have a bond with a core interst rate of 2% pa, and during the six month period we experience a deflation of 3% pa, your bond will not lose value. It will be worth whatever it was worth at the start of the 6 months. If you should redeem an I-Bond before maturity, you get the accumulated value, as long as you have held it for 5 years. On redemption after 1 year, but before 5 years, you lose 3 months interest.

Another important difference is that I-Bonds are tax-deferred. You don't pay until redemption, so you will have the cash to pay the tax.

For me, I-bonds are better than TIPs outside of a retirement account, given reasonably equivalent core interest rates.

The next question is, are I Bonds a better deal than EE bonds? Currently, with their very low core interest rate, probably not. I saw a study based on 50 years of data, which took the rules for I bonds, and the rules for EE bonds, and tried to determine which would return the most. Overall, if the core rate on the I-Bond is greater than 2.6%, take the I-Bond. If it is lower than 2.25%, take the EE bond. Tweeners are kind of a no-man's land where it could go either way. Although I Bonds are adjusted for inflation, and EE Bonds are not explcitly, EE Bonds adjust to current medium term interest rates by virtue of the fact that the interest rate floats, based on the 5 year T-note. Also, if interest rates should be so low that the EE Bond has not doubled by its 20 year maturity date, the treasury makes a one time adjustment to bring it up to its face value.(Face value is 2x purchse price in EE Bonds.) In effect, this gives an interest rate floor of about 3.6%.

To answer your other question about maturity- all Savings bonds have a maturity date, but they usually earn interest beyond this date. However, there is another date beyond which they will not earn interest, and they should be redeemed. Here is a chart-

E May 1941 - November 1965 -40 years
December 1965 - June 1980 -30 years

H June 1952 - January 1957-29 years, 8 months
February 1957 - December 1979 -30 years

Savings Notes All issues 30 years

EE All issues 30 years

I All issues 30 years

HH All issues 20 years

For any information about savings bonds, see:
http://www.publicdebt.treas.gov/sav/sav.htm

I hope this is helpful to you.

Mikey

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Re: Difference between I Bonds and TIPS??
Old 08-26-2003, 04:05 PM   #5
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Re: Difference between I Bonds and TIPS??

We have some 6% savings bonds from the early 90's. As originally issued, they paid the better of 6% or some percentage of the 5 yr Treasury bond rate. After 12 years at 6 % they will have doubled in value and are worth the face amount of the bond. (Series EE bonds are purchased for half the face amount, ie. a $100 bond costs you $50)

Once these bonds hit their face amount or "maturity" they contunue to accrue interest, but only at the current rate. Some of our bonds have hit this point and the rest soon will. We haven't cashed the things because I don't see any alternatives out there that would earn enough more to make up for taking the tax hit on the deferred interest.

Baanista
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Re: Difference between I Bonds and TIPS??
Old 08-27-2003, 12:17 PM   #6
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Re: Difference between I Bonds and TIPS??

Wow--ask and you really do receive!
Thank you for all the really good information.
These bonds are about to reach face value (a 12 year process for 6% bonds).
My original question was answered (after the bonds reach face value they no longer pay 6%, but 4%. I had read the government website, but the language was not clear (at least to me).
Thanks for explaining the tax consequences of TIPS. I had not been aware of them.
It does seem logical to just hold on to the EE bonds for a while.

Okay, here is another Pandora's Box.

Other than I-bonds, is there a fetching investment just as safe? I figure even with our zillion-trillion deficit, the government is going to have to pay up. Or put another way, I'm paying into social security IOUs with these bonds (I think). I have read about GNMA bonds, but wonder about them because of mortgage rates, etcetera.
My investment strategy has been KISS (keep it simple, stupid), with an emphasis on safety rather than return. Is there anything out there I should know about?

Thanks, thirdage
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Re: Difference between I Bonds and TIPS??
Old 08-27-2003, 02:26 PM   #7
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Re: Difference between I Bonds and TIPS??

Thanks for info.
Q: what do you mean by 59.5 (10 years) in savings bonds?
thirdage

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Re: Difference between I Bonds and TIPS??
Old 08-27-2003, 03:28 PM   #8
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Re: Difference between I Bonds and TIPS??

I- Bonds @ 6.77%?

As mentioned earlier I-bonds can be bought with credit cards until Dec 2003. If you have a rebate credit card, then you could increase your effective rate of return. For us we have a 529 credit card that puts 2% of purchase (yes I-bonds count) into a college fund. It may not add up to a lot, but where else can you get an extra 2% on your bonds? The 2% is credited at the end of the month, so you get an immediate benefit. This window of opportunity closes this December. There are probably other cards (retirement 1%, etc) that would probably work as well.

Just a thought on how to stretch those dollars.

earlyout
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Re: Difference between I Bonds and TIPS??
Old 08-28-2003, 12:37 PM   #9
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Re: Difference between I Bonds and TIPS??

earlyout,

have also been buying I-bonds with cash-back credit card.
you mention that this can be done until 12/03. will we no longer be able to pay with credit card after that date ?

thanks
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Re: Difference between I Bonds and TIPS??
Old 08-28-2003, 01:47 PM   #10
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Re: Difference between I Bonds and TIPS??

Quote:
Other than I-bonds, is there a fetching investment just as safe?
Fetching is very much in the eye of the beholder, but for me nothing right now is very attractive. At a time like this it often proves useful to play a defensive game-don't lose money, don't make big time commitments.

I am using two "parking places" for cash. The Orange Account, from ING Direct, which is an FDIC insured savings account paying 2% currently. It is very easy to set up, and link with your bank account. The other is not government insured, but it seems quite safe. It is a money market type account from GE Financial, whose credit rating is AAA. On deposits of $50,000 and over, it pays 2.25%. Both of these aim to stay competitive, and so if rates trend upward so will the interest paid on these accounts. There is no time commitment with either, which seems to me to be a good thing under current conditions.

Mikey
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Re: Difference between I Bonds and TIPS??
Old 08-30-2003, 03:05 AM   #11
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Re: Difference between I Bonds and TIPS??

Hi Mikey! I went heavy into corp. bonds back in the spring. Although I may make out fine, I wish now I had opted for your "parking places". The spread between
the 6% I was seeking and the 2% I could get at a
bank was irresistable. Now I wish I had resisted.
Hindsight!
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Re: Difference between I Bonds and TIPS??
Old 08-30-2003, 03:11 AM   #12
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Re: Difference between I Bonds and TIPS??

GMAC recently offered their Smartnotes (unsecured
corporate notes) with a yield of about 7.125%, long
term and callable. However, that's a real good rate
in the current market. While subject to credit and
market risk, GMAC is bigger than some countries, so it
looks pretty good to me.
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Re: Difference between I Bonds and TIPS??
Old 08-31-2003, 04:42 PM   #13
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Re: Difference between I Bonds and TIPS??

mikey,

Is that study that concluded EE were better than I-bonds online? Everything that I've always seen has completely dismissed EE in favor of I, but, once you mention it, it does seem possible that, with the current low "core" rate, EE bonds will play out better over the medium or long term.

A google search turned up a Kiplinger article, is that the one that you read?
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Re: Difference between I Bonds and TIPS??
Old 09-02-2003, 12:26 PM   #14
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Re: Difference between I Bonds and TIPS??

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A google search turned up a Kiplinger article, is that the one that you read?
Bongo,

I can't really say. I copied the article into a Word file, and I can't find the original website. You realize that EE bonds have only had their current rules since 1997, and I Bonds are very new also. So there really can't be a true historical test. Any test would be a simulation, with some variables unknown.

One could perform his own test by seeing if and by how much 90% of the 5 yr treasury rate would clear inflation over some number of past years. Then compare that to the current I-Bond core rate.

This would be suggestive, but not really definitive. For one thing, as the US Govt gets more and more of it's obligations indexed, I expect that they will shave CPI, or whatever is the current indexing metric. There is already talk about how the CPI over-states actual inflation. IMO, it understates it, but unfortunately they don't index by the Mikey Metric.

A scholarly and expensive book, "Triumph of the Optimists" by Elroy Dimson looks into all sorts of returns over much of the world for long periods. He points out that indexed bonds have been available in Britain for a long time, and overall the record hasn't been as good as one might expect. I have this book on order, but the above is what my brother reported to me as he owns the book, and knew I was interested in indexed securities.

For a one year period, it is clear that given the current rates, I-Bonds dominate EE.

In the past real interest rates have at times been negative for long periods. One would think that institutional changes in the 70's would make that less likely now, but who knows?

For me, the current I Bond core rate is not enough that I would want it as long term investment. If inflation jumps enough to make the nominal return attractive, I expect that there will be trading opportunities that will be even more promising, albeit more risky. And for that reason (liquidity) I would not want the one year funds tie-up of savings bonds.

Mikey
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Re: Difference between I Bonds and TIPS??
Old 09-03-2003, 04:02 PM   #15
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Re: Difference between I Bonds and TIPS??

FYI - Scott Burns has two recent columns in Dallas paper that compare I-Bonds, savings bonds, and TIPS. The second discusses tax consequences. He raves about I-bonds with the caveat that you must figure in taxes, which depending on your income, could put you into negative territory.

Also, it is my understanding that you also have to hold onto I-bonds for a year. Am I wrong?

thirdage
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Re: Difference between I Bonds and TIPS??
Old 09-05-2003, 01:30 PM   #16
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Re: Difference between I Bonds and TIPS??

Quote:
Also, it is my understanding that you also have to hold onto I-bonds for a year. Am I wrong?
No, you are right. For any bond bought Feb, 2003 or later, there is a mandatory 1 year holding period. After that they can be cashed, but you lose 1 quarter's interest, until the bonds have been held 5 years.

I would like to comment on the Scott Burns column you referenced. He is an excellent writer, but he makes one mistake in his description of I bonds. He says that the core rate, as well as the inflation rate change every six months. This is wrong. Only the inflation component changes. The base rate stays constant for 30 years from issue. Of course, since the inflation rate changes, the composite rate will change also, every 6 months. The rules are clear, but involved. The website referenced earlier in this thread has very clear discussions of everything pertaining to these bonds.

One last thing. When I bought some of these in October 2001, the treasury announced the new base rate to apply to new issues for the period beginning Nov1 until May 1, 2002, during October. So in effect you had the choice of waiting if the new rate would be better, or going ahead if not. This may still be true. Since the base rate continues 30 years, it helps to get a high one. This is particularly true if inflation is moderate going forward.

Mikey
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Re: Difference between I Bonds and TIPS??
Old 09-05-2003, 02:37 PM   #17
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Re: Difference between I Bonds and TIPS??

Thanks for clarification.

Didn't quite understand last paragraph.

Since rates will probably go up and I am now constructing my ladder, need to know exactly what you mean.

Do you mean you can buy the bond and choose the date of implementation (doesn't seem likely)? Or wait and hope that the rate does indeed go up?

Sorry about the lack of sophistication.

thanks, thirdage
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Re: Difference between I Bonds and TIPS??
Old 09-11-2003, 10:28 AM   #18
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Re: Difference between I Bonds and TIPS??

Some info on I-bonds % TIPs

TIPs accrue tax liability as owned, before any interest may be received. If placed into tax deferred account. it becomes "ordinary" income subject to state and local taxes.

I-bonds accrue tax deferred, until cashed in. Also, if used for education can avoid tax altogether. Also, not subject to state and local taxes.

earlyout
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Re: Difference between I Bonds and TIPS??
Old 12-21-2003, 07:49 AM   #19
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Re: Difference between I Bonds and TIPS??

Quote:
My EE-bonds from 1990 are currently earning 4%. *Not as good as 6%, but not as bad as current EE rates.
I'm confused. I thought EE bonds were variable rate, with their rates reset every 6 months based on the previous 6-month average of 5-year treasuries.

How does the initial coupon matter?
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