Sunday, December 2, 2007

Christmas Shopping Made Easy (An I-Bond Story)

Christmas Shopping Made Easy
In 1970, my cousin Betty gave me Creedence Clearwater Revival's "Bayou Country" for Christmas. You couldn't do much better than that for a teenager. But it was easy to do much worse -- another gift was an album by the Archies, which was not on my list for Santa.

There's that 1970 reference again. Okay, I'm listening.

We buy I-bonds in their names. I-bonds are savings bonds issued by the U.S. Treasury. Kids can't open their own accounts with the Treasury, but adults can buy bonds for them in their names. Every December, a $25 I-bond is put into a Gift Box linked to Uncle Buz's (a.k.a. "St. Nick") Treasury Direct account. It stays there, safe, sound, and earning interest based on the inflation rate -- well after some more fashionable gift has been broken, lost, or forgotten.

$25 to protect the kids? Okay, sounds good. At $25 a year, you'll be able to protect a good $500 in 20 years. Meanwhile, you keep swinging for the fences with your own money apparently.

Of course, a broad-market exchange-traded fund such as the iShares series offered by Barclays (NYSE: BCS), would be a better option ... for them. But paying a $10 commission for a single share of an ETF is a bit much for me. My hope is that when they turn 18, they can take that bond money and make some more diversified investments.

Of course it would be a better option? What arrogance! I'm doing everything in my power to get my money into I-Bonds. It is most certainly NOT a guarantee that I-Bonds will underperform his alternatives. This is yet another case of staring at the last 25+ years in the rear view mirror and expecting it to continue. Don't bring up 1970 and cousin Betty if you aren't at least willing to entertain 1970s style inflation though. Had I-Bonds existed in the 1970s, they would have outperformed every other type of U.S. Treasury and the vast majority, if not all, of the corporate bond funds as well. I am 100% convinced of that.

First, I-Bonds have a very difficult time defaulting. The government will print money in your honor. Corporations do not have that luxury on their bonds. Seeing as how we are still in a credit crisis of unknown magnitude, this alone could be worth a lot.

Second, I-Bonds earn an inflation adjusted return. If inflation rises, so does the earnings rate. Most bonds do not do that. You are stuck with the rate you started with. End of story.

Third, the interest is tax deferred up to 30 years. Should inflation rise and interest rates with it, deferring those taxes can have a huge impact on the overall return (as I have tried to show in previous charts).

Fourth, I-Bonds do not have any management fees. Why pay Barclays for what you can get for free directly from the government? How can you start with the premise that you want something for nothing, then also expect to pay someone else to give it to you for free? *baffled expression*

Fifth, while I-Bonds must be held one year you also have the option to hold them up to 30 years. If you cash them out before five years there is a slight penalty. After five years there is no penalty at all. If you decide later that you don't like the rate you were originally offered, presumably because better rates came along, you can sell them back with absolutely no loss (even after one year, since you simply lose some interest, not the principal). Try that with other bonds if things don't go your way. I can't easily put a price on what that safety's worth, but it is certainly worth something!

Sixth, there is a $30k annual maximum limit on I-Bonds. Why do you suppose that is? Why won't the government allow you to buy more than that? In my opinion, it is because the government isn't completely stupid. If it goes down the inflationary path it can't very well have every rich person in America protecting his or her entire net worth. That's why. It is the same line of thought that goes into putting caps on tax deferred IRAs.

Good grief. Of course Barclays is better? Is that how brainwashed we've become? Barclays is somehow adding a service that will enhance the returns on government debt? Now don't get me wrong. I like the Barclays funds. They've got reasonable fees compared to the others. In fact, the only funds I own are Barclays funds. I should say fund, since I'm entirely in TIP (Barclay's Treasury Inflation Protected Securities fund). The rest of my money is with the U.S. Government directly (short-term treasuries, TIPS, and I-Bonds).

As a side note, I just opened up a Treasury Direct account today. I already have a Legacy Direct Treasury Account (uses the Postal Service). I believe I can double the rate of my I-Bond purchases (since paper I-Bonds and Treausury Direct I-Bonds appear to have their own individual annual maximums).

I feel like the David Lereah of I-Bonds. There's never been a better time to buy! (Which isn't quite true, since 2000 was a fantastic time to buy. Oh how I wish there wouldn't have been an annual maximum then. I can honestly say my entire net worth would be in them earning that 3.4% real rate I was offered, since that's exactly what I was saying then.)

Speaking of the government not being completely stupid, I am extremely impressed with the safety features provided when setting up my new Treasury Direct account. Wall Street isn't nearly as concerned by comparsion.

This is not investment advice. I'm "betting" on stagflation and do not expect to make a dime in the upcoming years. I hope to merely hold onto at least some of what I have. I could be wrong on both counts of course.

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