Big turning point: ibonds went up to 6.96% in 2000,then stocks dropped. Now ibonds at 2.4%;Stocks to soar up like 2003?

brentpresley, you can clean up the post and put it in quick summary.

I'm not sure, but I think the iBonds are determined by a formula which assures a rate based on the CPI. That is suppose to be the whole point of the ibonds. The FIXED rate portion is the part the goverment can play with. I suppose they could decrease the fixed portion to less than the current 1.2%. But even if there were no fixed portion (ie 0%, which is very unlikely), then the CPi-adjusted portion is still 5.69% which is good for the following 6 months until it is subject to change on May 1, 2006.

You could argue there is a $60,000 limit per person per year for these ibonds so that should not effect the stock market. (I think there is an electronic format and a paper format for these ibonds; $30,000 permitted for each.) But if rates do go to 7% I think there will be a run from people with CD's too. That will cause banks to have huge outflow. Combine this with the FED now having even more pressure to continue to increase rates late in this economy and you have a turning point that is becoming more scrutinized.

Wow. I'm definitely going to start looking into this. Thanks for bringing it to everyone's attention, OP.

Great thread.

Cana nyone confirm this?

What determines the fixed rate portion of an ibond?

No one knows for sure. I had some email correspondence with Treasury, and I've read other accounts – I can't recall which of the following came from which source, but my understanding is as follows:

When the I-Bond was first introduced, the rate was set with an eye to choosing a rate that would create some level of sales. The early sales were low, and the fixed rate remained high. Eventually, people caught on to the attractiveness, and sales increased, so they were able to reduce the fixed rate to keep in line with their sales goals.

As time went on, they wanted to convert the quasi-arbitrary selection with a formula. While they haven't revealed the formula to the best of my knowledge, here is my guess at the formula:

Calculate the five-day average of the real component of the Five year maturity TIPS, on the eighth business day prior to the 1st of May and November.

Again, this formula is speculation, but it nails the rate for the last three issues, including the most recent one. The last one is important because it was an increase, when many people were predicting flat or a decrease.

We can't apply that formula until October 20, but today's rate on the Five year TIP (per Bloomberg) is 1.67%. It has been fairly volatile over the past couple weeks, so who knows where it will be on the 20th, but it seems likely it will be 1.6 or 1.7%.

Will the Treasury follow their formula? Is my guess at their formula correct? Hard to say.

Philster said: What determines the fixed rate portion of an ibond?

No one knows for sure. I had some email correspondence with Treasury, and I've read other accounts – I can't recall which of the following came from which source, but my understanding is as follows:

When the I-Bond was first introduced, the rate was set with an eye to choosing a rate that would create some level of sales. The early sales were low, and the fixed rate remained high. Eventually, people caught on to the attractiveness, and sales increased, so they were able to reduce the fixed rate to keep in line with their sales goals.

As time went on, they wanted to convert the quasi-arbitrary selection with a formula. While they haven't revealed the formula to the best of my knowledge, here is my guess at the formula:

Calculate the five-day average of the real component of the Five year maturity TIPS, on the eighth business day prior to the 1st of May and November.

Again, this formula is speculation, but it nails the rate for the last three issues, including the most recent one. The last one is important because it was an increase, when many people were predicting flat or a decrease.

We can't apply that formula until October 20, but today's rate on the Five year TIP (per Bloomberg) is 1.67%. It has been fairly volatile over the past couple weeks, so who knows where it will be on the 20th, but it seems likely it will be 1.6 or 1.7%.

Will the Treasury follow their formula? Is my guess at their formula correct? Hard to say.

But even without the fixed rate the CPI-based portion will still project an interest rate of 5.69%. The fixed rate portion, whatever it may be, will be ADDED to that portion.

Philster said: What is the earliest you could redeem the ibond bought at the end of Nov.?

One year, as your own cited information indicates.


Well if you get intrest for the entire month of Nov. I figured you might be able to sell early in the month of Nov the following year. Closer to 11 months than a year.

Closer to 11 months than a year.
You are nitpicking, but yes, it could be closer to 11 months, depending on which day of the month you buy. Why'd you ask if you knew the answer?

My concerns are two-fold:
1) if you need the money out after the 1-year period, you loose the last 3 mo of interest and don't make out THAT much better than say EmigrantDirect's Savings account (which, will most likely inch upward in the next few months as we all EXPECT the Fed to increase the Prime rate).
2) Lower liquidity (my wife is currently job searching).

Philster said: But even without the fixed rate the CPI-based portion will still project an interest rate of 5.69%. The fixed rate portion, whatever it may be, will be ADDED to that portion.

Yes, but don't over-react. Suppose, for the sake of argument, that the government sets the fixed portion at zero. If you say, that's OK, 6.59% is not bad, realize that you only get the 5.69% for six months. Then it will be reset at the new CPI. I think(hope?) the CPI is an unusual shock, not a harbinger of a new high inflation scenario. If the CPI drops, you are stuck with a zero real return for the life of the bond, or you have to sell it, which you can't do until a year, and then you give up a quarter of interest.

If they decide to drop the real rate to 1.0%, I would touch them. You can buy TIPS with a real component of 1.6-2.0%, depending on the maturity. (And, starting this month, you can buy them through Treasury Direct.)

I think that a drop in real rates would not happen. Today we have interest rates and inflation rates climbing* (inflation should reinforce higher interest rates right?). My bet is fixed will not go to zero (what's the point?), but will hold steady or go higher.

*as opposed to March 2000 with only interest rates rising, inflation remaining tame.

Rumors of the death of stocks and mutual funds at the hands of this 'riskfree' rate are highly exaggerated.

It's important to remember there is a big difference between nominal and real rates of return. The investor should focus more on the real rates underlying her assets, not the nominal rates. The inflation-adjusted interest rate on an I-bond is all nominal. It is the fixed rate on an I-bond which represents the real rate of return. If inflation really was at 5% for the next year, you'd still only be richer by the fixed 1+% on the I-bond at the end of the day, because prices would have risen by 5%. Of course, this is better than having your money in a CD or cash where you might end up poorer than where you were originally.

To a certain extent, stocks and mutual funds are a hedge against inflation just like I-bonds are. The value of a corporation is based on it's ability to make profits (very loosely speaking) and profits will of course go up nominally, if prices go up nominally as well. The real rate of return on stocks is much higher than 1% I-bonds, so they're still an important part of your portfolio. That being being said some people have observed historically negative short-term effects on stock prices from rising inflation rates, but the bottom line with stocks is that anything could happen - they're fundamentally risky investments and it's impossible to make predictions.

All that said, the I-bonds remain a good investment because of the decent risk-free real return and the inflation protection. But I don't see anyone getting rich anytime soon off I-bond investment strategies.

Given the unadjusted Sep 2005 CPI-U index of 198.8 and the Apr 2005 CPI-U of 194.6 the semi-annual inflation component will be an add on of 4.32% not the 5.69% OP stated.

This is flat Wrong.

The calculation uses September and March, not September and April.

There's only five months between April and September.

Negative feedback for misinformation:

You're half right. It uses the CHANGE in April, not the month-ending CPI-U value for April. If you use April's CPI-U value, you exclude the change in April from your calculation.

April end - September end is five months.
March end - September end is six.

ciba said: Negative feedback for misinformation:

You're half right. It uses the CHANGE in April, not the month-ending CPI-U value for April. If you use April's CPI-U value, you exclude the change in April from your calculation.

April end - September end is five months.
March end - September end is six.

So what is the projected CPI-based interest rate (before considering the fixed rate portion) after all this discussion?? 4.32% (plus the 1.2% fixed portion to yield 5.52%) seems more reasonable than the 5.69 (plus 1.2% fixed to yield 6.89%).

I see a lot of banks now offering over 4.5% for CDs 12-month or longer.

brentpresley said: One more question. Can these be used to pay for my wife's education loans that just went into repayment?

Can we double-dip? So to speak?
- can we deduct the interest from her education loans as they are repaid AND use these to repay them and not pay taxes on the gains?

I don't see why not. But remember you have to hold these bonds for minimum 1 year. You can redeem with 3-month interest penalty from years 1-5. But I don't know if that period also eliminates the FED TAX-FREE deal for education. If you have to wait the full 5 years to get the FED TAX-FREE status for education use, then that is a long haul.

asharerin, Philster probably could have stated it a bit nicer, but he is correct in saying that the calculation uses the CPI-U figure for March, not April.

I figured that you saw what you just quoted from the Savings Bonds website. That quote is misleading. Here’s another quote from the Savings Bonds website which I think is a little more clear:

"...the semiannual inflation rate we announce in November reflects the percentage change between the CPI-U figures from the preceding March and September."

So is it 4.32 or 5.69 as the CPI-based portion of the ibonds? (Then add the fixed portion which is anywhere from probably 1.2 - 1.7%.)

Not everyone thinks the stock market is going to take a dive in this rate enviroment.
Fears ignore current market valuations
Super-bulls set sights on Dow 40,000

Jon Markman of MSN Money is a momentum technical analyst. He does not have a good track record. I remember he wrote an article in 2000 severely criticizing Warren Buffett for missing the tech bandwagon. Well, we know what happened. If Buffett leads his flock to the dinner table to drink nectar, Markman leads his to the portable Johnny to drink toilet water.


slimcustomer said: Not everyone thinks the stock market is going to take a dive in this rate enviroment.
Fears ignore current market valuations
Super-bulls set sights on Dow 40,000