I Bonds: Limited to $10,000/yr, But Great Safe Savings Option

In an environment where earning a good return in a safe, savings vehicle is very difficult, I Bonds offer a wonderful and safe option - provided that you dont need the funds within a year. Think of the I bond as a 12 month CD.

Below is an excerpt from a 3/10/2012 WSJ article by Ruth Simon:

"I Savings Bonds, issued by the U.S. Treasury, offer one of the best deals for savers, though in small doses. Unlike a typical supersafe investment, the interest rate on I Bonds has two parts: a fixed rate that lasts for the life of the bond and a variable inflation rate that is adjusted twice a year based on changes in the consumer-price index. Currently, the fixed rate is 0% and the inflation rate is 3.06%, meaning investors receive a 3.06% yield.


"With I bonds, you are at least guaranteed to keep pace with inflation," notes Mel Lindauer, co-author of "The Bogleheads' Guide to Investing," a resource for fee-wary investors. I Bonds also have several tax advantages. Among them: They are exempt from state and local taxes, and interest income is tax-deferred.


One downside is that investments are limited to $10,000 per person per year, though you can also receive a tax refund of up to $5,000 in the form of an I Bond. The bonds generally can't be redeemed in the first 12 months, so they are best used as part of a multiyear emergency fund. Between years one and five, you will pay the last three months' interest as a penalty for cashing in early. After five years, the bonds can be cashed in without penalty."

Below is information from http://www.treasurydirect.gov/

I Savings Bonds In Depth

As of January 1, 2012, paper savings bonds are no longer sold at financial institutions.  This action supports Treasury’s goal to increase the number of electronic transactions with citizens and businesses. See the press release.

I Bonds are a low-risk, liquid savings product. While you own them they earn interest and protect you from inflation.  Once sold and redeemed solely as a paper security, they’re now also available in electronic form and in paper form through your IRS tax refund. As a TreasuryDirect account holder, you can buy, manage, and redeem I Bonds online.

A new program called SmartExchange^SM allows TreasuryDirect account owners to convert their Series E, EE, and I paper savings bonds to electronic securities in a special Conversion Linked Account within their online account.

Buying I Bonds through TreasuryDirect:

• Sold at face value; you pay $50 for a $50 bond.
• Purchased in amounts of $25 or more, to the penny.
• $10,000 maximum purchase in one calendar year.
• Issued electronically to your designated account.

Buying Paper I Bonds:

• Available only through your IRS tax refund
• Sold at face value; i.e., you pay $50 for a $50 bond.
• Purchased in denominations of $50, $75, $100, $200, $500, $1,000, and $5,000.
• $5,000 maximum purchase in one calendar year.
• Issued as paper bond certificates.

If you redeem I Bonds within the first 5 years, you'll forfeit the 3 most recent months' interest; after 5 years, you won't be penalized.

My Thoughts:

Lets assume that you buy $10,000 of I bonds and redeem after 1 year and forfeit 3 months of interest, your return will still be 75% of the inflation rate (CPI), after 2 years 87.5% 0f CPI, after 3 years 92% of CPI.  

If you invest today and earn the current stated rate of 3.06%  for the next 1 year (this adjusts every 6 months, so unlike a CD your rate will fluctuate). You then withdraw the funds after the 1 year waiting period. Your return will be approximately 75% of 3.06%, or 2.30%. Comapre this to current 1 year CD rates of  slightly over 1%.

Active vs. Indexing: Excellent WSJ Article

In a column in todays WSJ,  Karen Damato points out that in 2011 80% of active stock fund managers did not beat their respective benchmarks. But, so far in 2012, 64% are beating their benchmarks. She asks are they suddenly smarter?

Not necessarily; she points out that generally they are not suddenly smarter but rather the stocks that they are investing in are in favor. She writes:

"John Cochrane, a finance professor at the University of Chicago Booth School of Business, says investors are misguided if they think fund managers add—or subtract—value based on how savvy they are at picking individual stocks.

Managers typically have a strategy that favors certain kinds of stocks, such as those with rapid earnings growth or very low prices relative to earnings or rising dividends. Stocks with a common trait tend to rise or fall in market favor together. So the performance of a fund versus a benchmark can be better viewed in terms of the various factors a manager overweights or underweights, Mr. Cochrane says."

At the end of the day investors need to ask a couple questions:

1. If I am actively managing a portfolio, am I comparing the performance to the correct benchmark?

2. Am I earning a benchmark beating return for the fees I am paying?

What most will find is that it is a better long term solution to invest with low cost index funds.

For the complete article:

http://online.wsj.com/article/SB10001424052970203824904577215381237716676.html?mod=ITP_thejournalreport_0