EE bonds

[sevoflurane]

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What is the rational for using EE bonds with a return of .1%?.

I can open a Barclays online money market account and get .9%.

Is it because EE bonds are guaranteed to double in 20 years?

 

[pgg]

Hold for 20 years = doubled value, or effective 3.6% rate, which isn't bad these days for a low risk investment.

And unlike the MM account, fed bonds are exempt from state taxes, and federal taxes are deferred until redemption, so high rollers can squeeze some extra pseudo-tax-advantaged space. If used for education expenses they're tax free.


I prefer I bonds over EE for fixed income allocation on the taxable side of my portfolio, but you're limited to $10K/year there. (I think there's a loophole where if you overpay your est federal taxes, you can get your federal refund in I-bond form, allowing you to exceed $10K/year but I haven't been motivated or rich enough to look at that too closely.)

 

[sevoflurane]

Hold for 20 years = doubled value, or effective 3.6% rate, which isn't bad these days for a low risk investment.

And unlike the MM account, fed bonds are exempt from state taxes, and federal taxes are deferred until redemption, so high rollers can squeeze some extra pseudo-tax-advantaged space. If used for education expenses they're tax free.


I prefer I bonds over EE for fixed income allocation on the taxable side of my portfolio, but you're limited to $10K/year there. (I think there's a loophole where if you overpay your est federal taxes, you can get your federal refund in I-bond form, allowing you to exceed $10K/year but I haven't been motivated or rich enough to look at that too closely.)

Thanks man. That clears it up. 3.6% is indeed good. May I ask why you prefer I bonds over EE bonds?

 

[pgg]

Thanks man. That clears it up. 3.6% is indeed good. May I ask why you prefer I bonds over EE bonds?

Inflation indexing. I'm betting that during the holding period for bonds purchased now, the variable rate will exceed 3.6% eventually. And if inflation takes off and reaches levels we saw a few decades ago, as that paranoid market-predicting little voice in my head keeps telling me it will, I bonds will do better.

To paraphrase dr doze, all fixed income options kind of suck these days, and gov bonds may be the least ugly girl in the room ...

 

[countingdays]

I like preferred stocks instead of bonds. Floating rate preferreds should do better than bonds as interest rates rise but with somewhat higher risk. Any opinions on preferred stock, either fixed or floating or fixed-to-floating?

 

[pgg]

I like preferred stocks instead of bonds. Floating rate preferreds should do better than bonds as interest rates rise but with somewhat higher risk. Any opinions on preferred stock, either fixed or floating or fixed-to-floating?

I don't think any kind of stock/equity belongs on the "safe" (bond) side of my portfolio. I hold bonds to manage risk and reduce overall volatility. If I want higher returns and want to accept higher risk for those returns, I think the better answer is to increase the % of my portfolio that is equity. Not buy riskier bonds.

You say "I like preferred stocks instead of bonds" ... implying you don't own bonds. Everybody should own some bonds. The equity:bond ratio should depend on need and ability to take risk, but 100%:0% is probably not a great plan.

More broadly speaking, I don't like "preferred stock" because I don't like individual stocks. The stocks I own are various market index funds.

 

[countingdays]

I'm thinking more of an 80/10/10 split for equities/bonds/preferreds instead of 80/20.

A floating rate preferred trading for 18.00 with a 4% dividend floor yields 5.55% now and will yield even more as the libor goes up. It's hard to accept 3.6% for a bond when 5.55% is out there with preferred stock.
You have a point though that I could just go 90% equities and have likely better returns but higher volatility.

I'll definitely add more bonds when I'm closer to retirement and/or when yields are better and outlook is better. Don't you expect bonds to do poorly over the next decade?

 

[deleted126335]

Think of EE bonds as a 20 year tax deferred CD (state tax free) with an absolutely massive penalty for early withdrawal. I have bought the max of EE bonds for the last 3 years, but will probably pass in 2014. Interest rates have ticked up and the EE bond rate ( for early withdrawal) has ticked down. EE bonds bout as late as Oct 2012 were paying 0.6%. Still plan to buy the max of IBonds for myself and my wife in January.

 

[deleted126335]

I'm thinking more of an 80/10/10 split for equities/bonds/preferreds instead of 80/20.

A floating rate preferred trading for 18.00 with a 4% dividend floor yields 5.55% now and will yield even more as the libor goes up. It's hard to accept 3.6% for a bond when 5.55% is out there with preferred stock.
You have a point though that I could just go 90% equities and have likely better returns but higher volatility.

I'll definitely add more bonds when I'm closer to retirement and/or when yields are better and outlook is better. Don't you expect bonds to do poorly over the next decade?

There is risk in the preferred stock. I absolutely expect my bonds to underperform inflation on an after tax basis. But I hold them to dampen the volatility of an all equity portfolio and to provide a store of value when equities tank. I only hold very high quality bonds.

 

[pgg]

It's hard to accept 3.6% for a bond when 5.55% is out there with preferred stock.

Is that really different than saying "it's hard to accept 5.55% from a preferred stock when 9% is out there with stocks and 17% might be out there with emerging market microcaps"? Over the long term, expected return should correlate with risk. You're getting more from the preferred stocks because they carry more risk than bonds.

Your 80/10/10 is really 90/10. Maybe not wrong for a young high earner with many many years to go, but when an equity downturn comes (as it will, at some point) the real test will be whether or not you stick with 90/10 all the way through it. If you think you might change that 90/10 if the stock market dropped 30% next week, then maybe that change should be made now. During a stock market dip, the second tragedy of having no/few bonds in the portfolio (beyond the magnified loss from the stocks) is not having bonds to sell in order to rebalance into stocks.

 

[countingdays]

Is that really different than saying "it's hard to accept 5.55% from a preferred stock when 9% is out there with stocks and 17% might be out there with emerging market microcaps"? Over the long term, expected return should correlate with risk. You're getting more from the preferred stocks because they carry more risk than bonds.

Your 80/10/10 is really 90/10. Maybe not wrong for a young high earner with many many years to go, but when an equity downturn comes (as it will, at some point) the real test will be whether or not you stick with 90/10 all the way through it. If you think you might change that 90/10 if the stock market dropped 30% next week, then maybe that change should be made now. During a stock market dip, the second tragedy of having no/few bonds in the portfolio (beyond the magnified loss from the stocks) is not having bonds to sell in order to rebalance into stocks.

I'd say preferred shares have more in common with bonds than with stocks. There is a somewhat higher risk of losing everything than with bonds since bondholders are paid before preferred shareholders, who are paid before common stock holders, if the company goes bankrupt.
The more significant risk is that preferred share dividends can be suspended and, unless they are cumulative, will never be repaid. The dividend would have to be suspended for a long time to drive the yield down below that of bonds though. Also, it seems to me that the interest rate risk of bonds would be higher than that of preferred stock, especially compared with floating rate preferreds that could either produce a great dividend yield or get called at $25 for a nice profit as interest rates rise.

Of course this is compared to high quality, low yield bonds. There are obviously really risky bonds out there too. Also, if interest rates weren't so low, bonds would be more and preferred shares less appealing.

I'm not trying to discourage bond investment or push preferred shares. I am just interested to get other people's take on it. I think that they have a good balance between yield, risk, and holding value in a bear market, but I could be wrong. I've just recently hit the point where I have enough money invested in my retirement account that I've started to care about asset class diversification. (It's not that much really, but I'm working on it). I was disproportionately invested in large cap US equities, and I'm mixing it up a lot more from now on.

Anyway sorry, this thread was about EE bonds.

 

[deleted126335]

I'd say preferred shares have more in common with bonds than with stocks. There is a somewhat higher risk of losing everything than with bonds since bondholders are paid before preferred shareholders, who are paid before common stock holders, if the company goes bankrupt.
The more significant risk is that preferred share dividends can be suspended and, unless they are cumulative, will never be repaid. The dividend would have to be suspended for a long time to drive the yield down below that of bonds though. Also, it seems to me that the interest rate risk of bonds would be higher than that of preferred stock, especially compared with floating rate preferreds that could either produce a great dividend yield or get called at $25 for a nice profit as interest rates rise.

Of course this is compared to high quality, low yield bonds. There are obviously really risky bonds out there too. Also, if interest rates weren't so low, bonds would be more and preferred shares less appealing.

I'm not trying to discourage bond investment or push preferred shares. I am just interested to get other people's take on it. I think that they have a good balance between yield, risk, and holding value in a bear market, but I could be wrong. I've just recently hit the point where I have enough money invested in my retirement account that I've started to care about asset class diversification. (It's not that much really, but I'm working on it). I was disproportionately invested in large cap US equities, and I'm mixing it up a lot more from now on.

Anyway sorry, this thread was about EE bonds.

My take:

5yr AA corporate bonds are yielding 2.1%. You can find plenty of preferred stocks with dividends in the range of 6%. Why in the world would anyone own the former? Answer: because you are taking more risk with the latter. Plain and simple. The fact that you aren't aware of that risk doesn't mean it is not there. Preferred stocks can have more than their dividend suspended. Their price can crater. If the company is doing well (credit rating upgrade) the stock can be called.

http://www.cbsnews.com/news/why-you-should-avoid-preferred-stocks/

 

[Mman]

There is nothing inherently safe or risky about stocks, preferred stocks, or bonds. Each one must be evaluated individually. There are plenty of common stocks that are "safer" than some bonds. In general a bond is more likely to provide a return of capital, but that's not true in all cases. There are even instances when the common stock of a company can be a "safer" bet than a bond from the company, such as when the market cap of a company is worth less than the book value of the shares of stock. Not common, but it happens. Long term bonds can also lose their "safety" when inflation slowly steals their value.


Every investment should be evaluated on an individual basis.

 

[Gaseous Clay]

I buy both I and EE bonds. I consider it extra tax deferred space and it is guaranteed. As someone said, consider it a CD except its better IMO since it's tax deferred and free from state and local tax. Also as someone pointed out, you can invest more than 10k if you "overpay" taxes and have the refund money go towards the bonds (off top of my head, I think it's another 5k). Plus tax free for educational expenses, I see it as a solid investment if you've maxed out all other tax deferred space.

Honestly an investment like this won't change anything. When you're chilling in your nursing home room, you won't curse out how you wished you weren't so stupid and had invested in I and E bonds.

 

[ssmallz]

I feel like a lot of people knocking the lower rate of returns for bonds are missing the big picture. Bonds are meant to be a cash store for you to re-balance into stocks when necessary and prevent loss of capital in a down market so the most important aspect is preservation of capital, not ROR. Like others have said, when investing in bonds its more important to get high quality bonds that won't lose money then to increase your ROR by taking on more risk. You're basically hoping bonds will outperform putting the money into a MM account and keeping up with inflation so that when you need extra capital to take advantage of the down markets you have it at your disposal and you can deploy it to buy more stocks when they are cheap as well as a way to take money off the table after a nice bull market has thrown your portfolio into over weighting of stocks.

With that being said, I'm firm believer that for attendings just starting out, a 100% equity portfolio is likely the way to go in your SEP IRA until it builds to ~300-400k. Reasons being that 1) You can't take the $$ out for 30 years so you've got enough time to survive a bear market early on and 2) You can use your 50k/yr contribution as your capital preservation and re-balance fairly easily given the ratio between the size of your portfolio to the size of your contributions. As your portfolio grows in size, it becomes harder and harder to rebalance through your contributions alone and having bonds as a cash shelter becomes more attractive.

 

[sevoflurane]

When you rebalance on a bear market with held I/EE bonds, you cash them out with a penalty and @ a low interest (EE's are now .1%) correct? In other words, you never capture 3.6% since you did not hold them for 20 years?
Disclaimer: I 'm >95% equity + some muni bonds.

 

[deleted126335]

When you rebalance on a bear market with held I/EE bonds, you cash them out with a penalty and @ a low interest (EE's are now .1%) correct? In other words, you never capture 3.6% since you did not hold them for 20 years?
Disclaimer: I 'm >95% equity + some muni bonds.

No penalty if you hold at least five years.

 

[pgg]

100% or 95% equity may not be the best plan, even with a very long event horizon. Asset allocation isn't just maximizing likely returns, it's risk management.

From Ferri's book -

The lines aren't straight; there's a risk reduction advantage to holding more than one asset class.

 

[deleted126335]

100% or 95% equity may not be the best plan, even with a very long event horizon. Asset allocation isn't just maximizing likely returns, it's risk management.

From Ferri's book -

The lines aren't straight; there's a risk reduction advantage to holding more than one asset class.

 

[deleted126335]

It gets even better with the more asset classes you add on the equity side. Of course correlation coefficients change over time.

 

[sevoflurane]

Let me get this straight guys... So if you hold onto EE/I bonds for 5 years, you can cash out your bonds with a 3.6% return?

 

[Mman]

Let me get this straight guys... So if you hold onto EE/I bonds for 5 years, you can cash out your bonds with a 3.6% return?

No. My understanding is that while you don't pay a penalty for that withdrawal, the 3.6% interest is only applicable at the 20 year mark as the guarantee is that your money will have at least doubled @ 20 years. If it hadn't they adjust up to make it double (effectively a 3.6% rate for 20 years).

At the 5 year mark if you withdraw you'd only get the small amount of interest earned in the interim (0.1 or 0.2% right now).

 

[pgg]

Let me get this straight guys... So if you hold onto EE/I bonds for 5 years, you can cash out your bonds with a 3.6% return?

No, if you cash out your EE bonds before 20 years, you get your principal back and not much else. Given today's rates, that's a loss in real terms. It should be an absolute last resort. You shouldn't buy EE bonds with money you think you might want or need in less than 20 years.

I bonds are a little different. If you redeem them in the first 5 years, all you forfeit is the previous quarter's interest, not that big a deal. After 5 years, there is no penalty.

The rate on an I bond is what it is, a fixed rate set at purchase plus the variable rate. The magical 3.6% rate on EE bonds is a result of the fact that they're guaranteed to double in 20 years. 72/20 = 3.6. You don't get that "rate" until the day they tick over 20 years.

 

[deleted126335]

Again, think of EE bonds as a 20 year tax deferred, state tax free CD paying 3.6% with an absolutely massive penalty for early withdrawal. Think of 19 years 11 months as early withdrawal.

 

[sevoflurane]

Ok. So essentially, everything you put into a bond you shouldn't touch until it matures. Consider it gone unless you absolutely need it. I don't see the sense in ever pulling them out unless absolutely necessary, even in a bear market. I think I'd rather have a "bear market" stash in a money market account making .9%.

Doze, you've lived past a couple market crashes. Did you tap into your I bonds to better position yourself before the market fully recouped or did you try and keep them in bond land to try and grab that 3.6% down the line? I'm still not really seeing the value of I bonds unless you are committed to keeping them in there until they mature @ 20 yrs.

Thx for the posts.

 

[deleted126335]

Ok. So essentially, everything you put into a bond you shouldn't touch until it matures. Consider it gone unless you absolutely need it. I don't see the sense in ever pulling them out unless absolutely necessary, even in a bear market. I think I'd rather have a "bear market" stash in a money market account making .9%.

Doze, you've lived past a couple market crashes. Did you tap into your I bonds to better position yourself before the market fully recouped or did you try and keep them in bond land to try and grab that 3.6% down the line? I'm still not really seeing the value of I bonds unless you are committed to keeping them in there until they mature @ 20 yrs.

Thx for the posts.

No, I had lots other assets available for rebalancing.

EE bonds have a guaranteed doubling feature at 20 years. They reach final maturity at 30 years. Assuming interest rates don't change 20 years is the optimal holding period for EE bonds. I bonds have two components to their yield fixed and variable. Currently the fixed rate is 0.2% the variable is 1.18%. The fixed rate doesn't change over the life of the bond. The variable rate adjusts every 6 months based on the CPI.

 

[pgg]

Ok. So essentially, everything you put into a bond you shouldn't touch until it matures.

You don't have to buy individual bonds. Various bond index funds exist, which hold many many individual bonds, which may range from newly issued to almost mature such that the average duration in the fund is in line with the fund's objective.

There's little liquidity difference between shares in a low-cost Vanguard / Fidelity / Schwab bond index fund compared to a money market, and even now the expected return is higher than that of cash in a money market.

 

[countingdays]

Long-term treasuries are volatile and are fairly likely to provide a negative yield after inflation. I can see the logic in a short-term bond fund providing diversification and the ability to rebalance/buy low when equities fall, but I don't see the appeal of long-term bonds. TIPS maybe.

 

[ssmallz]

Long-term treasuries are volatile and are fairly likely to provide a negative yield after inflation. I can see the logic in a short-term bond fund providing diversification and the ability to rebalance/buy low when equities fall, but I don't see the appeal of long-term bonds. TIPS maybe.

The appeal is a safe place to park your money to remain liquid while minimizing the risk of losing it. The options are basically mm account or bond fund.....neither will perform great but the bond fund should outperform a mm account without significantly increasing your risk of loss in a bear stock market.....at least that's the theory

 

[deleted126335]

Not my words. Cut and pasted from the bogleheads forum. Another doc actually. His post is two years old. Agree with almost all:

BONDS WHAT THE DATA SHOW:

1. Risk taken in the bond arena is not rewarded in terms of lower credit quality. This means that you should stick to treasuries, AA/AAA or pre-refunded municipals, noncallable FDIC insured CD's, savings bonds, all noncallable or as uncallable as possible (many munis are callable just the last year, this should not be a big deal). Avoid lower grade munis, corporates of any kinds, GNMA's, callable bonds, junk bonds, emerging bonds or foreign bonds. This is because while over certain periods these assets may seem to do well, over the long term the risk has not been rewarded and includes equity correlation. Ever see Total Bond Market? It has done better and is more efficient than a comparable intermediate treasury only bond fund. However, when you mix the respective bond funds with equity, the 5 year treasury/equity portfolio outperforms because the treasuries are less correlated. The corporate and GNMA part of total bond tends to lose value at the same time that equities do, thereby depriving you of the rebalancing bonus and losing portfolio efficiency.

2. Durations less than a year have no equity correlation. Durations up to 5 years start to increase equity correlation. Durations past 5 years strongly correlated with equity. Sweet spot for treasuries is never more than 5 years, municipals is about 6-7 (Depending on curve).

3. Extending duration from 5 years, which is generally the sweet spot for treasuries, to 20 years has over the last 60 years only increased real returns 40 basis points. That is a high price to pay for the volatility of longer bonds.

4. You can extend duration from 1-3 years to say 3-7 years if you make an allocation to commodities of say 5% of your AA and rebalance faithfully. This actually increases portfolio efficiency because it exploits the longer bonds capital appreciation in falling rate environments when stocks otherwise tank, but hedges the longer bonds volatility because commodities are very volatile and will upsurge if interest rates were to rise.

5. Long bonds? Actually, long bonds produce a more efficient portfolio when you are talking about a portfolio that is heavily weighted towards equity. Therefore, if you have 70% equity or greater, the volatiliy of the portfolio is controlled by the equity anyhow so extending the bond duration will not appreciably worsen your overall volatility, and actually helps offset risk somewhat. Sharpe ratios (the measure of reward vs amount of risk taken) is actually better in heavily equity portfolio with 20 year average duration treasuries than with only 5 years. However, if you have a portfolio that relied heavily on fixed income, a duration of greater than 5 years is hazardous to its health and should be avoided.

6. If 5-7 year yields don't appeal to you, you can safely reach for yield in the following manner: by building a ladder. Buy equal amounts of dollar weighting in debt maturing 10% each in every one of the next 10 years: 10% in 2012, 10% in 2013 etc. When the bonds mature, you buy the next 10 year bond that will fit (10 year muni, 10 year treasury, 10 year TIP whatever). This way, you will have a bond portfolio with an average maturity of 5 years whose overall performance characteristics will match that of a 5 year bond but once you set up the ladder, all new bonds or bonds you roll over will always get the 10 year yield. It's one of the few free lunches in fixed income investing. The other is the volume premium in municipals. Stick to odd lots, lots of 5 or 10 bonds. They will carry higher yields because of the liquidity premium. If you have to sell before maturity on these highly illiquid small lots that no one wants, you will get a huge haircut. If you keep, however, you can get some great deals. I have recently gotten 4% yield on a 10 year pre-refunded, and 1.5% yield going out 18 months, both pre-re's backed by treasuries.

7. TIPS help portfolio efficiency due to their safety, and you can safely extend up to about 15 year duration because you don't take inflation risk, even longer, but given low yields recently it would be more prudent to limit maturities to no more than 15 years. If you buy the individual tips and hold to maturity, they can never go to below par value and therefore also provide good deflation protection because no matter how much they and the dollar deflates, you might lose the CPI adjustment but never the coupon and never mature for less than 100% which is what you paid for it (more or less, some second auctions later in year have slightly higher or lower prices).

8. Consider having a good part of your bond allocation in your tax deferred be TIPS, and your taxable bonds be high quality munis that are preferrably pre-refunded. Also consider federal agency bonds and CD's in taxable for your very short term part of the ladder, as their after tax yield can, but not always are higher than the municipals.
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at this time I don't hold any TIPs because the real yields are too low for me. They are the only long term bonds that I would consider. I don't buy individual munis, only funds. Vanguard and Baird (BMBIX)- like the credit quality of the last one. Highest quality Munis are currently yielding about 95% of treasuries. Making them relatively cheap.