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I vs EE vs TIPS
Old 10-23-2007, 07:05 PM   #1
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I vs EE vs TIPS

Are there any recommendations for which type of bonds to use to build an emergency fund?

I want to use these bonds to start building an emergency fund so I dont have to see the the money sitting in a HYS every time I access my bank accounts. That has been a proven way for me to fail in the past. I have the option to automatically withdraw I/EE bonds of various denominations with every paycheck so it will be easy to force myself to save. Basically it will let me kill 2 birds (trouble with forced saving and problems with spending savings) with 1 stone.

Im not sure about the differences between them. Based on initial research, I bonds are based on CPI, EE bonds are based on 6 month treasury rate, and TIPS are also based on CPI? If thats true, what is the difference in rate determination between I and TIPS bonds?

Are there any other recommendations about bonds I should know about? Thanks in advance.
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Old 10-23-2007, 11:26 PM   #2
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I-bonds don't have a very attractive rate currently. Wait till November to see what the new rate will be, but TIPS generally yield at least 1%/year more.

I'm not sure I understand your goal. Sounds like you're looking for an illiquid investment so you can hide some cash from yourself? You just don't want to see the daily balance on a report?

In that case, I guess i-bonds would do the trick. But it's pretty easy to cash them in at the bank. Are you sure you'll be able to resist the urge to liquidate for non-emergencies?
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Old 10-23-2007, 11:37 PM   #3
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There must already be a thousand threads on this.

TIPS pay more than I bonds, BUT they have a set maturity date, you can not defer their taxes, you must pay income taxes on the yearly inflation adjustment despite not receiving it in spendable cash, and if you are talking about smallish dollar amounts, the commission required to sell them before maturity can sting. However, other than the commission, there are no restrictions on selling them almost immediately after you buy them. There is no practical limit on how many dollars worth of TIPS you may purchase.

I bonds pay a lower interest rate than TIPS, but you can defer their taxes, you pick (between 1 year and 30 years) when they mature, and they are available in much smaller denominations than TIPS. However, you can NOT sell them during the first year you own them. You pay a three month interest penalty if you sell them within the first five years you own them. You can only buy $30,000 via Treasury Direct plus $30,000 in paper bonds per year. Some would say that last rule is to protect the wealthy.

Closely related, Vanguard and other fund companies offer TIPS based mutual funds. The advantage is that it is easy to buy/redeem the exact amount you want, and you get TIPS higher interest rate. At least in Vanguard's case, I believe they also rig things so that they distribute the TIPS inflation adjustment, thus you receive the cash you need for your taxes. However, you do pay the mutual fund company a management fee which partially offsets those advantages.

Though TIPS have always paid more than I bonds, I do wish I had purchased some I bonds back when they first came out paying much higher interest rates. I know I would not have risked purchasing a 30 year TIP, but if I had purchased I bonds in 2000, I would now be able to hold them for 30 years, which given the change in interest rates would currently make great sense. It just didn't seem to make sense at the time.

Personally, I am building a five year ladder of TIPS as part of my bond allocation. I buy them at issue, and plan to hold them to maturity. However, as an "emergency fund" I bonds or a mutual fund might make more sense, because you can buy them and mostly forget about them, knowing you can redeem just what you need when you need it with extremely minimal transaction costs.

Any posting about TIPS and I bonds would be incomplete without including a reference to TreasuryDirect which is the best starting place for most individual investors. At least until their portfolio grows large enough for companies like Vanguard to offer them no commission auction purchases.
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Old 10-24-2007, 11:52 AM   #4
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I'm not sure I understand your goal. Sounds like you're looking for an illiquid investment so you can hide some cash from yourself? You just don't want to see the daily balance on a report?

In that case, I guess i-bonds would do the trick. But it's pretty easy to cash them in at the bank. Are you sure you'll be able to resist the urge to liquidate for non-emergencies?
My problem has been that when I have cash in my savings account dedicated specifically for emergencies, everything starts looking like an emergency. I know its pretty simple to say what is or isnt an emergency in the passenger seat, but that understanding is usually hindsight for me.

Im looking to bonds for several reasons: 1. I can buy them automatically in each paycheck. No more thinking. 2. They have a forced waiting period of at least a year. This again will remove me from spending the money. 3. I dont have a local bank, so it will not be that easy for me to cash them even after a year.

Its not the ideal solution, but its A solution. And thats what I am needing now.
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Old 10-24-2007, 12:23 PM   #5
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I also have some of my emergency fund money in I-bonds. I estimate that if I really need to tap them, I'll probably be in a lower tax bracket so better to defer the taxes. And as bam noted, you'll have to pay taxes annually on TIPS, both on the principal adjustment and the interest payment, which you'd have to roll back into your fund.
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Old 10-24-2007, 01:24 PM   #6
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ChemEng....

If you have a problem then you need to address the problem... buying a different kind of investment will not help out at all...

But, here are two choices.... save some money up and then put it in a one year or even a 5 year CD... when it matures, resist the urge to spend and roll it over.. if you REALLY need the money you will not worry about the lost interest for cashing it in...

Put the money in a savings account at a different S&L (one with a good rate)... every once a year or so, throw in some more money... when you get the statement DON'T OPEN IT... just file it away...

Again, if you can not follow either of the above two, you will not follow the savings bonds either..
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Old 10-25-2007, 10:24 AM   #7
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MY EF is in CDs. Three CDs, each 90 days in duration. You can open a CD at mos banks for $1000, then add to it 90 days later... we have 3 CDs each at 3k (so a 9k EF).

BAMSPHD's post was good. Based on that information, and purpose of an EF, I might suggest:

Quote:
TIPS pay more than I bonds, BUT they have a set maturity date, you can not defer their taxes, you must pay income taxes on the yearly inflation adjustment despite not receiving it in spendable cash
Quote:
I bonds pay a lower interest rate than TIPS, but you can defer their taxes, you pick (between 1 year and 30 years) when they mature
In either case, the money appears to be tied up for 12 month minimums. Hardly a good EF (if I have a 1500 car repair bill next month, I would need to pay fees to get money in both cases).

If a person could open 12 accounts of I bonds, maturing 1 month apart, that would be a good way to do things (but investments would be cash heavy). In my case this would put close to 36k in cash investments, and I don't think I need that much cash.

TIPs appear better for a true EF, but you would need to have lots of TIPS unless there is a maturity date on either security less than 12 months.
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Old 10-25-2007, 10:29 AM   #8
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I built about half of my emergency funds in I-bonds (back when the fixed rate component was 3.4%, in 2000). I don't really like them now with the current rate, especially given the CPI-U's tendency to understate inflation for so many people. At least with the I-bonds I have, the 3.4% fixed rate tends to wipe that out and then some. Plus, the deferral of federal taxes (and being state income tax free, which isn't a bonus for me in Texas but helps others) is nice, too.

I wish I had the ability to buy more of 'em back then at that rate; there have been six-month periods when they have been yielding 7% or so. Now that I have the money, the rate stinks.
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Old 10-25-2007, 02:49 PM   #9
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BAMSPHD's post was good.
Thanks.

Quote:
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In either case, the money appears to be tied up for 12 month minimums. Hardly a good EF (if I have a 1500 car repair bill next month, I would need to pay fees to get money in both cases).
In the case of TIPS as an emergency fund, you would redeem the bond early by selling it on the secondary market, basically the same way you would sell a stock. You would have to pay a commission, and it would take a few days to have the money in hand. However, you definitely would not need to wait until maturity. You could easily get the money before your credit card bill arrived.

In the case of I bonds, it would take you a year to establish your emergency fund, but once established you could redeem the bonds whenever you needed them.

One additional note, because redeeming TIPS early requires paying a commission, while I bonds and mutual funds do not, if you are going to slowly build your investment or expect a relatively small total investment I bonds and mutual funds are a better choice. If you have a $2,000 emergency fund the sales commission could really hurt, if you have a $200,000 emergency fund the sales commission is not material. Personally, I am somewhere between those two numbers. So I don't like to make more than one TIPS purchase per year to minimize the potential transaction costs of an early exit. A money market account, short-term bond fund, or a TIPS fund are all good places to accumulate the funds for a single bulk TIP purchase.


People have different definitions of emergency fund. Personally, I keep at least a month or two of float in a money market account to pay for things like car repair bills, which for me are an unscheduled but expected expense. My "emergency fund" is in a short-term bond fund for things like unexpected hospitalization, house burning down, car totaled, or job loss. For those things I want at least six times my normal monthly expenses available someplace very liquid but not too volatile. Finally, I am building a TIPS ladder to handle stock market volatility issues during retirement (hopefully REAL SOON NOW ). The rest of the portfolio goes into equities.
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Old 10-25-2007, 03:14 PM   #10
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another good post by bamsphd

the root point is to determine what an EF is used for.

For me car repairs, house repairs and loss of job top the list. So for me 3 months expenses.

However, for a retiree, anticipating higher medical bills, or other large in frequent expenses might be the norm.

In my case CDs tie up the money enough to keep it out of reach, but mature quick enough I can get the money with a trip to a bank which is open 7 days per week.

If waiting 2-3 days is OK to get access to money, the TIPs or I-bonds approach would work. IMO this is not good enough for me, but might be good enough for a more thought out plan.

Using TIPs as a portion of a bond position which doubles as EF sounds risky to me... CDs and money markets better for my taste.
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