Forecasting I-Bond earnings

[Bruceski44]

I just checked these out here. The bonds have two rate determiners:
1. The fixed rate (currently 0.00%) for the life of the bond.
2. The CPI-U inflation rate determined on May 1 and Nov 1 (currently 3.56%)
The composite rate is shown, but when the fixed rate is 0.00% (as it will be for the life of any bonds bought now) it works out to 2x the inflation rate, or 7.12%.

The pros are well-known, primarily being risk-free.

There are a few cons which prevent me from filling my basket:
1. The inflation rate underestimates true inflation, even though it includes gasoline and food costs.
2. The inflation rate is readjusted every 6 months.
3. The interest is compounded every 6 months.
4. The bonds are good for 30 years, but if you sell before 5 years has elapsed, you lose 3 months interest.
5. The bonds must be held at least one year.
6. Once inflation returns to "normal" levels, you will be holding an investment earning near-zero interest again.
7. With a 0.00% fixed rate, you miss out on an additional kicker calculation for the rate earned - for the life of the bond.
8. You are generally limited to buying $10,000 per year per person.

My conclusions:
1. If buying now, you may get a year or more of >7% rates, compounded semi-annually. After that, composite rates will drop, possibly to 3%-5% range. Not compelling.
2. They are somewhat liquid, but with a penalty of one-half of one compounding period if sold before 5 years.
3. The real inflation rate is being underestimated, especially essential fixed costs like home heating, car fuels and food.
4. Due to the limited purchase quantities allowed and underestimated inflation, these do not represent an effective inflation hedge to me.
5. If inflation persists, and interest rates go up (both pretty unlikely with all the financial engineering we're seeing), these bonds may be a good hedge, as long as the fixed rate is >0% when purchased.

Earnings example in attached image. 3.81% XIRR after 5 years if inflation returns to normal within 3.5 years. Note: Normal inflation is <1% per the page linked above. Meh.

 

[Sunset]

Due to the limits I-bonds are and will be a small part of my fixed income set.

While the OP's cons seem true, they are much worse for bank CD's where a 5 yr CD earns 0.85% at best, and has a bigger penalty.

So I'll load up on i-bonds each year, and if inflation returns to 0%, I can always sell the I-bonds at that time, and the penalty will be 3 months of 0% - so no penalty.

If OP can show me a better CD rate, I'm happy to buy that as well.

 

[njhowie]

There are a few cons which prevent me from filling my basket:
1. The inflation rate underestimates true inflation, even though it includes gasoline and food costs.
2. The inflation rate is readjusted every 6 months.
3. The interest is compounded every 6 months.
4. The bonds are good for 30 years, but if you sell before 5 years has elapsed, you lose 3 months interest.
5. The bonds must be held at least one year.
6. Once inflation returns to "normal" levels, you will be holding an investment earning near-zero interest again.
7. With a 0.00% fixed rate, you miss out on an additional kicker calculation for the rate earned - for the life of the bond.
8. You are generally limited to buying $10,000 per year per person.

With all of these, there is nothing you can point to which will provide anything close to the I Bond risk free return at this time. Even if you were to hold for just one year then sell and forfeit 3 months of interest.

If you do have something, please share.

 

[finnski1]

With all of these, there is nothing you can point to which will provide anything close to the I Bond risk free return at this time. Even if you were to hold for just one year then sell and forfeit 3 months of interest.

If you do have something, please share.

I agree. This is the first time I have purchased any I bonds. For the $20k limit it seemed like a no brainer for at least a one year term. After that I will reevaluate every rate adjustment. I was getting less than 1% on those same monies. I see no cons at all.

 

[Koolau]

Yeah, one of the unfortunate consequences of living in these times is that there are very few "good" choices available for cash-like investments. I-bonds seem to be the best of the "bad" choices available. My bottom is sore from kicking myself for not buying more I-bonds in the early 00's. Sometimes, you don't know what you've got 'til it's gone. YMMV

 

[Bruceski44]

I appreciate all your comments.

Risk is personal and relative. My risk tolerance increased after realizing we were in a near-zero return environment. I cope by reducing my exposure to any one investment. I own no bonds and use investment-grade real estate to mimic that stabilizing effect. I've discussed my RE prefs before on here, but will add that all my RE investments have collected and paid out 100% of pro forma estimates since 2014, even through lockdown.

I will say that the more I analyze the I Bonds, the more I feel I can load up this year and next and earn pretty good returns in the short term. If inflation drops, I can unload them as @Sunset said above, because the earnings will drop off badly. It irks me that the real inflation rate is so badly underestimated. In the years since the global financial crisis, most years have rated 1% or less inflation, according to the page linked in my first message. I always felt it was closer to 2%, which doesn't sound like much, but is twice what they say.

 

[Bruceski44]

Updated table

There were two errors in my first analysis, which didn't really make a difference in the XIRR, but here's an updated version with another way to specify the return.

 

[jollystomper]

Due to the limits I-bonds are and will be a small part of my fixed income set.

While the OP's cons seem true, they are much worse for bank CD's where a 5 yr CD earns 0.85% at best, and has a bigger penalty.

So I'll load up on i-bonds each year, and if inflation returns to 0%, I can always sell the I-bonds at that time, and the penalty will be 3 months of 0% - so no penalty.
If OP can show me a better CD rate, I'm happy to buy that as well.

+1

I look at this as a "CD-type" opportunity, for that area of my AA, just better. After a year the 3 month penalty will not be as much if inflation falls. I am using cash on hand so I am fine with it .

 

[steelyman]

I’m hoping my I Bonds will outlive me!

 

[Bruceski44]

correct calculations now included

I'll let this thread die after I confess that I put out bad info with the tables I posted herein. I have 100% confidence in this table (below) and realize the return is pretty good after all, since the interest is compounded every 6 months. The interest is added to the principal and six months later new interest is calculated on the increased principal amount, which is commonly known as compound interest.

I couldn't leave my bad maths posted without correction.

 

[oldtimer]

I'll let this thread die after I confess that I put out bad info with the tables I posted herein. I have 100% confidence in this table (below) and realize the return is pretty good after all, since the interest is compounded every 6 months. The interest is added to the principal and six months later new interest is calculated on the increased principal amount, which is commonly known as compound interest.

I couldn't leave my bad maths posted without correction.

Third time is the charm?

 

[Chuckanut]

"Never let the perfect become the enemy of the good."

In regards to I Bonds I might rewrite this today as:
"Never let the perfect become the enemy of the good or the better."

I am old enough to remember the great inflation of the 1970's and early 1980's fairly well. One big difference between then and now is that interest rates on secure savings available to the the average person followed the inflation rates up, Up and UP. I remember T-Bills in double digits, bank savings accounts paying 6%, and CD's paying in the 7-10+% range. While these interest rates still lagged the inflation rate, they were at least closer than we are today. Miles closer.

Today, other than the I Bonds, savings rates on safe funds are being kept incredibly low compared to inflation. To quote the late Senator Bob Dole - Where's the outrage?

We fight back any way we can with any weapon at our disposal. Right now I Bonds are a useful, if limited, weapon. I would rather put the extra $650 on a $10,000 I Bond in my pocket than on the profit sheet of a bank. Or maybe I'll give it to the Grands for future educational expenses.

 

[SALTedOut]

Question about the above calculation. It appears the calculation is assuming the composite rate is paid every 6 months making the annualized rate twice that amount. Seems like every 6 months only 1/2 of the composite rate would be paid.

So I guess my question is wether the composite rates is an annualized rate or the actual 6 month rate? Or am I looking at the calculation totally wrong?

 

[Montecfo]

I have not found these particularly attractive though if you want some inflation protection, they work a lot better than TIPS I'd say.

I find the limits to be a sizable negative but I am looking at this differently now. With $20k in I-bonds, you can earn more than $100k at 1.00 percent in my favorite savings account.

So why not do $40k? Can add to or subtract as world returns slow growth and low inflation. If inflation continues at higher than usual rates, can keep adding.

 

[Bruceski44]

Question about the above calculation. It appears the calculation is assuming the composite rate is paid every 6 months making the annualized rate twice that amount. Seems like every 6 months only 1/2 of the composite rate would be paid.



So I guess my question is wether the composite rates is an annualized rate or the actual 6 month rate? Or am I looking at the calculation totally wrong?

I'm inferring based on this paragraph from the website:
The interest is compounded semiannually. Every six months from the bond's issue date, all interest the bond has earned in previous months is in the bond's new principal value. Interest is earned on the new principal for the next six months. For example, in month seven, interest is earned on the original price plus six months of interest. In month 13, interest is earned on the original price plus 12 months of interest. (However, values displayed by the Savings Bond Calculator for bonds that are less than five years old do not include the latest three months of interest. These values reflect the interest penalty.) If you hold the bond for at least five years, when you cash in (redeem) the bond, you receive all the interest the bond has earned plus the amount you paid for the bond.

It's written about as clearly as every other gov't website... I wonder how that always happens. Anyway i won't be certain until 6/2/2022, but believe i have it right. It clearly does NOT say APR anywhere.

 

[Bruceski44]

I'm inferring based on this paragraph from the website:
The interest is compounded semiannually. Every six months from the bond's issue date, all interest the bond has earned in previous months is in the bond's new principal value. Interest is earned on the new principal for the next six months. For example, in month seven, interest is earned on the original price plus six months of interest. In month 13, interest is earned on the original price plus 12 months of interest. (However, values displayed by the Savings Bond Calculator for bonds that are less than five years old do not include the latest three months of interest. These values reflect the interest penalty.) If you hold the bond for at least five years, when you cash in (redeem) the bond, you receive all the interest the bond has earned plus the amount you paid for the bond.

It's written about as clearly as every other gov't website... I wonder how that always happens. Anyway i won't be certain until 6/2/2022, but believe i have it right. It clearly does NOT say APR anywhere.

See here
https://treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm

 

[friar1610]

I bought a bunch back in the good old days (2001 and 2003) and then stoped for quite a while. Got some lower-fixed rate ones in 2019 & this year. I’ve spent about $110K in total and the current value is a tad south of $250K. I’ve already bought my limit for 2021 but will be buying my 2022 limit the first week in January. Don’t see any better cash/fixed income deals around. Nor, I suspect, will there be any reason to redeem the earlier ones short of 30 years.

 

[SDFarmer]

Bought a 10k one for both my wife and I a couple of weeks ago, and will do the same in January. I figure on holding for a minimum of 15 months on all of them as I’m guessing May’s rate will be pretty good as well. I’m sitting on some cash anyway, so I may as well have it do something. Even if it went to 0% in May it’s a 3.5% ish gain for a year.

Who knows, I may just end up holding for good too.

 

[finnski1]

Bought a 10k one for both my wife and I a couple of weeks ago, and will do the same in January. I figure on holding for a minimum of 15 months on all of them as I’m guessing May’s rate will be pretty good as well. I’m sitting on some cash anyway, so I may as well have it do something. Even if it went to 0% in May it’s a 3.5% ish gain for a year.

Who knows, I may just end up holding for good too.

Exactly my plan and thoughts as well!

 

[Koolau]

Only slightly off topic: How are I-Bonds "inherited?" Anyone know the process? Thanks.

 

[SnowballCamper]

I just talked DW into putting our emergency fund into I-bonds. She had opened a treasury direct account over a decade ago, but it mostly sat unused after the initial I-bond buy. As mentioned above, this sure beats any CD or savings account for cash holdings that you don't need to spend tomorrow (and can wait the minimum one year to redeem).

 

[steelyman]

One of my I Bonds just passed the 5-year mark today (redeemable with no penalty).

That’s good and motivates me to get my future purchases in early (I’m done for this year). I also have them as part of an “emergency fund” and don’t think about them once they’re bought (I haven’t redeemed any to date - no emergencies!).

 

[Chuckanut]

.

. I also have them as part of an “emergency fund” and don’t think about them once they’re bought (I haven’t redeemed any to date - no emergencies!).

+1

An excellent idea, IMO. That just occurred to me. You beat me by at least 5 years. Good job!

 

[bobbyr]

+1

An excellent idea, IMO. That just occurred to me. You beat me by at least 5 years. Good job!

I'm late to the party too, but just glad to participate...waiting for the calendar turn for another purchase

 

[Teacher Terry]

Bought one last month and will buy another in January.