No, the title of this post is not the analog of “I, Pencil” for bonds. The post is about a new kind of Treasury bond issued by the feds. Financial economist Burton Malkiel, who wrote the article on interest for David R. Henderson, ed., The Concise Encyclopedia of Economics, has an excellent explainer in the Wall Street Journal.
Here’s an excerpt:
Is there a solution for this investing dilemma? Unless you have a huge portfolio, the answer is yes: Invest in U.S. Treasury I Bonds. These bonds pay a fixed rate for the life of the bond, plus the annualized CPI inflation rate. With the interest compounded semiannually, these I Bonds will pay a total annualized interest rate of 7.12% through April 2022, well in excess of any other safe yield obtainable. You can never receive a negative real yield, and the combined interest rate can never be less than zero even if the price level declines. If inflation rises, the rate will go up when it resets in April. In other words, you’re safe from the economy’s current monetary woes and any measures the Fed takes to deal with them.
This is from Burton G. Malkiel, “The Treasury Has a Bond Bargain for You,” Wall Street Journal, December 15, 2021.
Malkiel points out that the returns are exempt from state and local income taxes.
The limit per person is $10,000.
READER COMMENTS
Squints
Dec 26 2021 at 8:11pm
I’m pretty sure I Bonds have been around for a while. They just didn’t get a lot of attention to that article. Then I fielded a lot of calls. People are happy enough to deploy the $10k but it doesn’t move the needle for many of them.
It’s possibly a small tell of Treasury’s intentions that it doesn’t want people buying these in volume.
Matthias
Dec 26 2021 at 9:36pm
Seems like a blatant subsidy for people rich enough to invest in bonds? Though with relatively low limits per person.
So: welfare for the middle class?
Thomas Lee Hutcheson
Dec 27 2021 at 3:33am
If they are sold at auction, there is no subsidy.
David Seltzer
Dec 27 2021 at 4:42pm
Right Thomas. The public is lending the government money for a 7.12% return. Is it any different than a person buying corporate bonds that will be used to acquire assets and increase production. As for subsidies, the government (taxpayers) subsidy to farmers in 2021 was about 1.8 billion dollars. The CBO projects federal subsidies, taxes, and penalties for health insurance coverage for people under age 65 will result in a net subsidy from the federal government of $920 billion in 2021.
Matthias
Dec 28 2021 at 6:15am
The government owes it to tax payers to borrow as cheaply as possible.
These bonds are rationed by something other than price, as you can see by the limit on individual purchases. That suggests they are not the cheapest way for the government to borrow.
If a company was offering bonds on similar terms, the shareholders could sue for breach of fiduciary duty.
Matthias
Dec 28 2021 at 6:28am
I don’t think these are sold at an auction. (That wouldn’t really work with the purchase limits per person per year either.)
There’s also no secondary market for them.
vince
Dec 27 2021 at 12:59pm
How is the Ibond a subsidy? The real rate of return is zero.
Matthias
Dec 28 2021 at 5:53am
Doesn’t matter what the real rate of return is, here. What matters is the opportunity costs of other government financing on one side and the opportunity costs of other investment opportunities on the other.
As there’s a limit to how much you are allowed to invest (and we don’t have the same restriction on normal government bonds), I assume it’s because these bonds are a sweetheart deal that needs rationing by something other than prices.
Matthias
Dec 28 2021 at 6:40am
PS The real rate of return on many other government bonds is negative.
vince
Dec 28 2021 at 1:00pm
If real rates are negative, then the subsidy is this: savers (wealthy?) are subsidizing borrowers.
vince
Dec 28 2021 at 1:07pm
Mathias wrote: “As there’s a limit to how much you are allowed to invest (and we don’t have the same restriction on normal government bonds), I assume it’s because these bonds are a sweetheart deal … ”
Or it may be that the government wants to inflate away its debt, and Ibonds are in the way. It didn’t start out with a limit.
Thomas Lee Hutcheson
Dec 27 2021 at 3:39am
Is this something different from the TIPS? If they are to be issues various maturities, they could be useful additions to the TIPS for observing interest rate expectations at different periods into the future.
Matthias
Dec 28 2021 at 6:26am
It looks like there’s no secondary market for I bonds, thus no market price to get information out of.
At least according to http://news.morningstar.com/classroom2/course.asp?docId=5398&page=7
Vivian Darkbloom
Dec 27 2021 at 5:18am
The purchase of I bonds is restricted to US citizens, residents and civilian employees of the US government.
Another small but important addendum: The limit per person is not simply $10,000 per person but eligible persons are limited to purchasing $15,000 *per year*. I say $15K per year because $10K per year can be bought through normal channels and an additional $5K per year if you choose to use your tax refund for the purchase (imagine making a larger fourth quarter estimated tax payment?).
Also, interest on I bonds can be deferred for federal income tax purposes until they mature or are redeemed (up to 30 years later) or can be reported annually, at the option of the taxpayer. However, accrued interest on the I bond is “income in respect of a decedent” and thus is taxable as ordinary income to the decedent on the last return, the estate, or the beneficiaries (advantageous if they have a lower rate). I view this as a disadvantage compared to stocks and other capital assets which afford the beneficiary a step-up in basis for accrued gains.
I bonds might be a good choice if one wants to make an annual gift to children in order to save for educational expenses. On the other hand, while the annual rate of interest currently of 7.12 percent sounds like a good deal, in fact, the real rate of return is *zero*. Stated otherwise, the fixed rate of return on the current I bond is zero and the remainder is the inflation adjustment. See, here:
https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
This might be a fair inflation hedge, but I’m not sure it’s a good investment. I think I’ll stick to my S&P 500 ETF.
David Seltzer
Dec 27 2021 at 4:52pm
“This might be a fair inflation hedge, but I’m not sure it’s a good investment. I think I’ll stick to my S&P 500 ETF.” Yes. The 7.12% rate hedges buying power. My portfolio includes the IWM ETF as well as the SPY. Also, I can alter my exposure to time varying risk with calls and puts on any ETF I trade.
MarkW
Dec 27 2021 at 6:50am
My wife and I just bought $20K this year, will buy $20K more in January and 5K for 2021 at tax time. It is still a money loser (the 7% interest only keeps pace with inflation and you have to pay federal taxes on the ‘returns’), but it’s the best deal going for cash right now.
MarkW
Dec 27 2021 at 8:17am
Oh, and another reason to check out I-Bonds is to behold probably the very worst web site I have seen in decades. In 2021, it’s a near miracle of incompetence and backwardness. If you hit the back-button, you are logged out. You cannot log in by pasting in your password or even by typing it in — you must click an on-screen keyboard (where — and I’m not sure I’ve seen this before — passwords are not case sensitive). And shockingly there’s no proper two-factor authentication.
I think you could almost turn somebody into a libertarian by having them go through the process of using the web site and asking them think about why it’s SO bad compared to the commercial web sites of even most small businesses.
Jon Murphy
Dec 27 2021 at 8:38am
The Treasury Direct website is something special…
Dave
Dec 31 2021 at 9:45pm
The onscreen keyboard prevents keyloggers from snagging your password. The email mechanism provides a form of two-factor authentication.
Mark Barbieri
Dec 27 2021 at 6:43pm
You can squeeze in another $5,000 purchase with money from a tax refund, but that amount is per return, not per person. So a married filing jointly couple could by $25,000 in a year – $10,000 for each person plus the $5,000 from the tax refund.
If you want bonds, it’s a good deal. But the limits prevent it from being a useful strategy for well-off bondholders.
Mark Barbieri
Dec 29 2021 at 7:47pm
Just found out that the iBonds you buy must be held as paper bonds, like in the olden days. They have a 30 maturity period and you hold them in the form of a piece of paper. When you want to cash them out, you have to go to a bank and sign them. I need to check to see if you can use a ballpoint pen to sign them or if they require that you quill pen.
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