Wednesday, October 31, 2007

TIPS vs. I-Bonds



This is a chart of an I-Bond purchased today and held 30 years. You don't have to hold it 30 years but you can (that is an added bonus). It is tax deferred while you own it and that's what makes the low 1.3% real yield worth thinking about. Tomorrow we'll be getting a new rate (or the same one) and it will apply to all I-Bond purchases made over the next six months. I'm planning on buying again in January, for what it is worth.



This is a chart of the 10 year TIPS. In order to make it comparable to the 30 year I-Bond you must continually reinvest any proceeds. It is assumed in this chart that you can get the same rate you can now (for better or worse, it is not necessarily a good assumption). TIPS are not tax deferred. Should inflation rise, those taxes would really start to hurt (depending on your tax bracket perhaps especially so).



This shows the breakeven point. As you can see, TIPS pay better if inflation remains relatively low (and also do better if your tax rate is low). I-Bonds do much better by comparison if inflation doesn't remain relatively low (and also do better if your tax rate is high).

This analysis is only valid if you hold 30 years. I-Bonds do progressively worse if you sell them early. You wouldn't be getting maximum benefit out of their tax deferred nature. Further, you can't sell I-Bonds in the first year and you are penalized three months interest if you sell them before five years.

This analysis also assumes inflation is a constant over the period. The breakeven point would be more favorable to TIPS if inflation slowly rose as opposed to simply jumping higher in the morning.

And lastly, if you don't believe the government's CPI numbers are close to reality, then this would obviously not be something you'd be interested in. That's for each person to decide for themselves. I happen to be in the camp that believes the CPI is relatively accurate. For each thing I see rising in price, I can find something that isn't. For example, we just bought canned soda on sale for 20 cents a can. I can remember back when I first moved to the Seattle area and was downright giddy if I could get 6 cans (brand name) for a dollar (on sale). That was 20 years ago. No joke. So where's the inflation in Coca Cola products, assuming you are frugal and take advantage of the sales when they appear?

I hope this helps. This is not investment advice. I am merely sharing thoughts on my investments with you. I own both TIPS and I-Bonds. I also have some money in TIP. I sleep better with the I-Bonds, but the government limits how much you can buy. I just keep right on buying every year though. That does not mean it is a good thing to do. Should we hyperinflate, neither I-Bonds nor TIPS would protect you. Should we experience more productivity miracles, there would be far better places to invest the money. Nothing is easy.

And lastly, my goals might be VERY different from your goals. I'd be perfectly happy just holding onto what I have and merely keep up with inflation from this point forward. I have very modest needs.

See Also:
Comparison of TIPS and Series I Savings Bonds

4 comments:

  1. You don't include the amazing feature of I-Bonds which is their tax-free use for college tuition.

    How does your comparison work if the I-Bond is used in this manner? It would seem the tax free compounding over many years would significantly outpace the annually taxed returns of a TIP.

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  2. Anonymous,

    Yes, tax free compounding would be a big bonus.

    I should mention that the yields have changed since writing this.

    The real yields on the I-Bonds offered today have fallen to just 0.7%.

    Meanwhile, the real yields on the 10-Year TIPS have risen to 2.23%.

    I-Bonds aren't quite as good by comparison as they once were. That being said, I'm still buying more I-Bonds this year (and TIPS too). I will wait to see what real yields are looking like heading into May though.

    If real yields are collapsing again, I'll lock in the current rate in April. If real yields rise, I'll wait until the I-Bond yields reset in May (and possibly even wait until they reset again in November).

    This isn't investment advice though. I'm just saying what I plan to do.

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  3. This has been a VERY helpful blog to me. Thank you so much for sharing this.

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  4. Foster Cline,

    Thanks!

    Just keep in mind that these charts are very old. Real yields are much lower now.

    ReplyDelete