Treasury Bonds?

[kork13]

For the last number of months, I've been considering buying U.S. Treasury I-Series bonds as a secure portion of my savings for eventually buying a home (not even a remote possibility for the next 4 years, and not likely for a while after that).

I'm going to be getting a raise shortly, so I'm thinking I may use part of it to buy $100/mo of these I-Bonds. This would represent 40% of my monthly savings toward buying a home.

I'm primarily looking at it for 3 reasons: 1) absolute safety; 2) moderate returns (average rate of 3.95% over the last 5 years); and 3) inflation protection (I'm sort of expecting an inflation spike sometime over the next 5-10 years).

I'm sort of just looking for your thoughts... Do you think this is a good (or at least reasonable) idea? Should I buy them myself through treasurydirect.gov, or by payroll deduction? Also, is there anything I should consider that I seem to be missing right now? I'm totally new to the bonds side of investing, so I'm open to anyone's thoughts/ideas.

[bones72]

Yeah kork, me too! Although I inherited these HH bonds, the thought of converting them to TIPS is really intriguing. Anyone else with some thoughts on this escapade?

[disneysteve]

Forget the past performance data. It is meaningless here. I bonds have 2 components to their rate: a fixed rate that is the same for the life of the bond and an inflation rate that changes every 6 months. Right now, the fixed rate is 0.30% and the inflation rate is 1.53%, so a bond purchased today will earn 1.83% from now until May 1, 2010 when the inflation rate adjusts.

As to how to buy them, do it yourself, not through payroll deduction. Here's why. I-bonds accrue interest monthly. You get credit for a full month's worth of interest regardless of when in the month you purchased the bond. So it is to your advantage to buy the bond as late in the month as possible. Buy a bond on December 31 and get credit for a full month of interest for December, for example. If you do payroll deduction, you can't time your purchases that way.

[bigredmachine05]

I am buying 5000 from my bank tomorrow to get the november credit and another 5000 from treasurydirect.gov. These are the limits for the year. The other thing I do is buy them in 1000 dollar increments. The accrue interest tax free which is a nice benefit. Also, you don't have to pay state income tax which is somewhat high in New Jersey.

[kork13]

Forget the past performance data. It is meaningless here. I bonds have 2 components to their rate: a fixed rate that is the same for the life of the bond and an inflation rate that changes every 6 months. Right now, the fixed rate is 0.30% and the inflation rate is 1.53%, so a bond purchased today will earn 1.83% from now until May 1, 2010 when the inflation rate adjusts.

I may be confused, but the website seems to read that the current rate (APY) is 3.36%, but they have a kinda screwy equation for calculating it... But thanks for the tip on timing buys at the end of the month.

[disneysteve]

I may be confused, but the website seems to read that the current rate (APY) is 3.36%, but they have a kinda screwy equation for calculating it... But thanks for the tip on timing buys at the end of the month.

Actually, I found that confusing, too. It looks like the inflation rate isn't annualized so an inflation rate of 1.5% would actually be an annual rate of 3.0%. I'm not sure what that formula is supposed to mean.

[amarowsky]

You have it correct you the 1.5% is just 1/2 the year what you receive in the six months(in addition to the fixed rate). And Steve is right about buying at the end of the month, one person I use to talk to at work often about finances always told me to buy I bonds at the end of the month, he always did and would get that extra month interest packed into a investment of a couple of days. I trust him because he's about 40 years older than me with well over seven figures, he's the epitome of Frugal. Over a million dollars in assets, takes every free offering from work whenever he can, still missing a tooth he refuses to fix because he doens't need to and doesnt want to pay, and drives a car as old as my usual cars, and I roughly have assets equal to 1/2500 of what he has.

Perhaps a bit too frugal for me, but I took his advice and I bonds are an excellent way to save. They do limit the amount you can buy a year to $5000.00 and you could just as easily walk up to any national bank at the end of the month n' pick up 100dollar bond. Sounds like a good savings plan for a house!

[simpletron]

The first two terms of the formula should be fairly obvious - Fixed annual rate and 2 * inflation SEMI annual rate. The last term comes from you earning interest on interest(fixed on inflation and inflation on fixed). Compare to the first two terms, the last is much smaller, on the order of hundredths of a percent. for example if you took an semi annual inflation rate of 10%(close to the highest in the last hundred years) and a fixed 3.6%(the highest one), then the last term would add .36% compared to 23.6 for the first two terms. buying now(fixed = .3), the last term will be under .01% most of the time.

[disneysteve]

Two other comments.

Not only should you buy at the end of the month, but for the exact same reason, you should redeem at the start of the month. Redeem on the 1st of the month and still get interest for that entire month.

Doing the timing thing also cuts the interest penalty for early redemption from 3 months to 1 month just in case you are ever forced to redeem early.