FANOFJESUS
Thinks s/he gets paid by the post
The CD at the local bank pays 2.2% and the I Bond pays 3.3%?
If you had $5000 would you buy a CD or an I Bond?
- Thread starter FANOFJESUS
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Warning: I am not an expert on I-Bonds:
How did you get the 3.3% number for the I-Bond? The Treasury site shows that I-Bonds purchased today would have a rate of .3% (fixed portion of rate that doesn't change for the life of the bond) + 1.53% ( the inflation portion of the rate, which will be in place only until May, then a new rate will be announced that will affect all I-Bond that have been issued) = 1.83% total.
How long do you plan to keep this investment?
1.53% is the inflation rate for the 03/09 to 09/09 6-month period, so the new ibonds will earn 1.53 x 2 +0.3 = 3.36%
Series I to Earn 3.36%, Series EE to Earn 1.20% Fixed Rate, When Bought from November 2009 Through April 2010
What is the maturity date on the 2.2% CD?
Thanks for the explanation.
FANOFJESUS
Thinks s/he gets paid by the post
It is a one year CD. If you cash in the I Bond before five years you forfit 3 months instrest. I am not sure which is better so I thought I would ask. Will an I Bond go down if rates raise?
On order to be able to compare the ibond and 1-year CD, you have to assume that you will cash in both investments in 1 year time.
3 things to consider: 1) the withdrawal penalty on the i-bond (3-months worth of interests); The money in the ibond cannot be redeemed for at least 12 months (you can't use it for an emergency) and 3) ibonds are exempt of state income taxes.
Since I do not know what you state tax rate is like, I will ignore that for the moment. In order to break even, and taking the withdrawal penalty into account, the ibond would have to pay 3.36% for the first 6 months and 2.08% for the next 6 months. That's an annual inflation rate of 1.78% (compared to 3.06% currently). If your state income tax rates are high, the break even point is even lower.
I think it would take another major downturn in the economy in Q1 2010 for the ibond to lose out to the CD.
3 things to consider: 1) the withdrawal penalty on the i-bond (3-months worth of interests); The money in the ibond cannot be redeemed for at least 12 months (you can't use it for an emergency) and 3) ibonds are exempt of state income taxes.
Since I do not know what you state tax rate is like, I will ignore that for the moment. In order to break even, and taking the withdrawal penalty into account, the ibond would have to pay 3.36% for the first 6 months and 2.08% for the next 6 months. That's an annual inflation rate of 1.78% (compared to 3.06% currently). If your state income tax rates are high, the break even point is even lower.
I think it would take another major downturn in the economy in Q1 2010 for the ibond to lose out to the CD.
FANOFJESUS
Thinks s/he gets paid by the post
Thanks Firedreamer. My income is low enough not to pay any state income taxes. If I bought the Cd, I would just buy another one at maturity. One more question Firedreamer can an I Bond lose value?
No, the ibond cannot lose value. The worse case scenario is you earn 0% interest for a while (as happened earlier this year).
kyounge1956
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One thing that isn't clear to me about inflation protected bonds is can they go below face value temporarily? As I understand it, to calculate the interest for each 6-month period, you multiply the inflation-adjusted face value by the permanent interest rate. What happens in the event of deflation? You always get at least par when you redeem a bond, but if you don't redeem it is the interest always calcuated based on at least the par value of the bond, or on the inflated/deflated value, even if that is below par at the time?
The I-Bond cannot drop below "par". The worst that happens is the interest rate can be zero.
The other consideration with the I bond vs CD is that the I bond compounds interest tax free until maturity.
One other consideration with the I bond is that the penalty is the LAST three months interest. So if you do have another period of low or no interest (first time I experienced that was the last six months) you can trade a 12-60 month old I bond for essentially no penalty. This would be of value if the fixed rate goes up and your existing I bonds had lower fixed rates.
Our I bonds, bought with fixed rates of 1-2 pct, have consistently made over 4 pct in combined interest. Of course, this was in a climate where some six month periods were considerably higher interest than others. This with no federal tax as the money grows, and no state tax ever, makes the effective rate significantly higher. Combine that with interest exemptions for education expenses (if you have kids off to college) and they become a pretty good, very safe, deal.
Disadvantage is that the new limits effectively make them worthless for significant investment. You can buy to the limit in paper, and in e-form, but it's still not a major coup for someone who is FIREd.
CD rates seem to be flirting with increases a bit, so if you went that way I'd either go short term, or real long term with the possibility of bailing in the future for higher interest.
Our I bonds, bought with fixed rates of 1-2 pct, have consistently made over 4 pct in combined interest. Of course, this was in a climate where some six month periods were considerably higher interest than others. This with no federal tax as the money grows, and no state tax ever, makes the effective rate significantly higher. Combine that with interest exemptions for education expenses (if you have kids off to college) and they become a pretty good, very safe, deal.
Disadvantage is that the new limits effectively make them worthless for significant investment. You can buy to the limit in paper, and in e-form, but it's still not a major coup for someone who is FIREd.
CD rates seem to be flirting with increases a bit, so if you went that way I'd either go short term, or real long term with the possibility of bailing in the future for higher interest.
bosco
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Here's a good explanation of TIPS and I bonds during deflation:
How Deflation Would Affect TIPS and I-Bonds - The Wallet - WSJ
One difference between the two:
"Unlike TIPS, I-Bonds adjust their interest rates to match inflation, not their principal amounts. The interest rate investors receive on I-Bonds includes two parts, one fixed at the time of purchase and a second one tied to the Consumer Price Index. Usually the combined rate is higher than either of the two components, but if the inflation component ever fell below zero, it would be subtracted from the fixed rate, diminishing investors’ returns."
How Deflation Would Affect TIPS and I-Bonds - The Wallet - WSJ
One difference between the two:
"Unlike TIPS, I-Bonds adjust their interest rates to match inflation, not their principal amounts. The interest rate investors receive on I-Bonds includes two parts, one fixed at the time of purchase and a second one tied to the Consumer Price Index. Usually the combined rate is higher than either of the two components, but if the inflation component ever fell below zero, it would be subtracted from the fixed rate, diminishing investors’ returns."
An additional consideration is that you do not have to hold the I-bond for the full 12 months. You can hold the I-bond for 11 months and a few days and still get 12 -3 months interest at redemption.
This is due to the fact that if you walk into a bank on the last business day or two of the month (as we've done a number of times) you will get an I-bond with that month printed on it (for example purchase on 11/27/2009 will show 11/2009). You can then redeem that bond on 11/1/2010 (which is a Monday). You are then free to deposit the money elsewhere, such as in a high interest online FDIC insured savings account, and recoup a chunk of the 3 month penalty.
This is due to the fact that if you walk into a bank on the last business day or two of the month (as we've done a number of times) you will get an I-bond with that month printed on it (for example purchase on 11/27/2009 will show 11/2009). You can then redeem that bond on 11/1/2010 (which is a Monday). You are then free to deposit the money elsewhere, such as in a high interest online FDIC insured savings account, and recoup a chunk of the 3 month penalty.
FANOFJESUS
Thinks s/he gets paid by the post
Thanks everyone.
I Bonds mostly better than CD's, buy late in month betgter than early
As I figure, a Series I savings bond outperforms most currently available bank CD's for any period from 1 year to 5 years IF you assume future CPI measured inflation to be more than 3%. Also addition it is interest deferred for income tax, which could be an advantage. The primary disadvantage is an annual nominal limit of $5000 which can be $10 per person or $20K per couple. The main advantage is if you expect annual inflation greater than 3%.
An I bond cannot be cashed within the first year. The 3 month penalty during the first 5 years is minimal, 1/4 of the annual interest rate. At 3.3%, at the end of 1 year when cashed the earned interest after penalty would be 2.48%, better than any 1 year CD that I know of. Two years at 3.3% would be a bit better compounded than 6.6%, and after the same 0.82% penalty would be a rate of 2.89% average per year, better than CD's 2 year rates. Bank CD's typically have 6 mo. penalties so the same strategy of buying a long term bond with a higher rate and cashing early is not as applicable.
As a minor point, an I bond calculates interest for the entire month of purchase, so a bond purchased at the end of January counts for the full month. Thus a bond bought just before the first of the next month would, in effect, have only a two month penalty if cashed later early in a month. By the same token, for maximum interest earnings, cash an I Bond early in the month, you won't get any more cash by waiting around to the last of the month.
There is a $5K limit per year for paper bonds, and $5K for Direct purchase at USBONDS.GOV. So if you set up a treasury account there (non-trivial) and buy a $5K bond, you can go to any bank and buy another $5K bond. You can make your spouse a co-owner on both if you want, then let her buy similarly two 5K bonds using her name an SS number with you as co-owner, a total of $20,000. If that is too rich, buy smaller bonds, of course.
-zzyp-
As I figure, a Series I savings bond outperforms most currently available bank CD's for any period from 1 year to 5 years IF you assume future CPI measured inflation to be more than 3%. Also addition it is interest deferred for income tax, which could be an advantage. The primary disadvantage is an annual nominal limit of $5000 which can be $10 per person or $20K per couple. The main advantage is if you expect annual inflation greater than 3%.
An I bond cannot be cashed within the first year. The 3 month penalty during the first 5 years is minimal, 1/4 of the annual interest rate. At 3.3%, at the end of 1 year when cashed the earned interest after penalty would be 2.48%, better than any 1 year CD that I know of. Two years at 3.3% would be a bit better compounded than 6.6%, and after the same 0.82% penalty would be a rate of 2.89% average per year, better than CD's 2 year rates. Bank CD's typically have 6 mo. penalties so the same strategy of buying a long term bond with a higher rate and cashing early is not as applicable.
As a minor point, an I bond calculates interest for the entire month of purchase, so a bond purchased at the end of January counts for the full month. Thus a bond bought just before the first of the next month would, in effect, have only a two month penalty if cashed later early in a month. By the same token, for maximum interest earnings, cash an I Bond early in the month, you won't get any more cash by waiting around to the last of the month.
There is a $5K limit per year for paper bonds, and $5K for Direct purchase at USBONDS.GOV. So if you set up a treasury account there (non-trivial) and buy a $5K bond, you can go to any bank and buy another $5K bond. You can make your spouse a co-owner on both if you want, then let her buy similarly two 5K bonds using her name an SS number with you as co-owner, a total of $20,000. If that is too rich, buy smaller bonds, of course.
-zzyp-
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