The Sun's Financial Diary » Bond

Approach Bonds With Caution

David Dierking — Wed, 03 Aug 2011 12:27:56 +0000

Even though the debt reduction deal reached just before the deadline prevented the United States from defaulting on its national debt, the crisis isn’t really over. There are still a lot of uncertainties going forward. During uncertain times, investors often run towards the safest investments they can find. Historically, that safe haven has been government issued Treasury securities but with those now standing on shaky ground investors are looking for the next best thing. Many will take a long look at corporate and other short-term instruments. That could be a mistake.

When there is turmoil in the markets or in the economy, people naturally tend towards conservative investments. They look for investments that fluctuate relatively little in value and can pay a steady income while in the process waiting out any turmoil in the market. But bonds and bond funds don’t necessarily appear to be that conservative right now.

Take into account where bonds and bond funds currently sit from a value perspective right now. Interest rates continue to hover near all time low levels and there’s not much room left for them to drop even in ideal economic conditions. In the current environment though, there are several events on the horizon that could push rates higher in the near term.

The first is the huge amount of government debt. Even before the drop dead date for Congress to come to a resolution, the perception in the markets is that United States government debt is starting to become riskier. It’s still rated AAA but there’s the threat of a downgrade even as the default has been avoided and the huge federal debt number can’t be ignored. As the risk of government debt rises, the interest rate that the government needs to pay on that debt will rise as well. Rising rates make existing debt with lower rates on it less valuable which is not good news for bond investors.

The second is an economic recovery. Given that the economy has been struggling for almost three years now, that possibility seems more like a sparkle on the horizon instead of a legitimate prospect but it’s going to happen sooner or later. When the economy starts picking up and unemployment returns to more normal levels, we’re going to see rates start rising to a historically more normal level. That rise in rates will hurt bond prices too.

The only scenario in which rates will continue to remain low is if there is continued economic weakness. In that case, the Fed will likely keep rates low in order to stimulate activity and get things going again. But bond prices rise when rates go down and considering that rates are already at historically low levels there doesn’t appear to be much upside remaining.

Bonds should always retain a place in your portfolio as an investment that can help hedge and offset the risk that comes with other riskier investments like stocks. But if you’re looking to switch money from stocks over to bonds thinking that it’ll be safer there and you’ll have a better chance at a solid return, you need to be cautious. There are several pieces of evidence to suggest that bonds might not be the safe haven you’d expect given the current market conditions.

If you’re considering an investment in bonds right now, it’d be best to temper your expectations and approach with caution.

Photo credit: aar0on

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Approach Bonds With Caution

I-Bond Rate for November 2009 – May 2010 Is 3.36%

Sun — Fri, 06 Nov 2009 04:15:56 +0000

The last time I wrote about I-Bond interest rate was last May when the Treasury Department set the total earning rate of Series I-Bond issued from May to November to 0.00% due to the negative annual inflation rate, which has already affected the contribution of 2010 401(k) plan.

Even though that I-Bonds purchased in the past six months didn’t earn me anything, I still kept my monthly purchase of $100 I-Bone intact because the investment was made through an automatic purchase plan and I was too lazy to cancel the orders that I planned for many years. Plus, since most savings account interest rates were below 2% during that period of time, it wouldn’t make much difference if I put the $600 somewhere else. So I decided to avoid the hassle and stick to my plan.

Now, six months later, a new I-Bond rate is announced for the next six months from November 2009 to May 2010 and it is too bad, at least for six months. According to the Treasury, the total earning rate for I-Bonds from November 2009 to May 2010 is 3.36%. The rate for I-Bonds consists of two part: A fixed rate plus an inflation adjusted rate. Of the 3.36% rate, 0.30% is fixed throughout the life of the bonds, which is 30 years. The inflation adjusted rate is 3.06%, not too bad but it lasts only 6 months.

I have been buying I-Bonds for more than 6 years, but I never maxed out (I believe putting the money in the stock market will give me a better return). Since I don’t have any bond mutual funds in our taxable investment accounts, I treat the I-Bonds I own as the fixed income portion (which they really are BTW) of our investment portfolio, even though I never really considered it in the asset allocation. However, I do want hold them for the long term

Update: The I-bond interest rate from May 2010 to October 2010 is 1.74% APY.

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I-Bond Rate for November 2009 – May 2010 Is 3.36%

I-Bond Rate for May 2009 – November 2009 Is 0%

Sun — Sat, 02 May 2009 15:09:04 +0000

I hope you have bought some I-bonds before May 1, so you can still enjoy a little bit the 5.64% yield I-bond rate that was good till April 30. If you missed the deadline and bought some bonds yesterday, May 1st, then too bad because the rate for Series I Savings Bonds issued between May and October will earn you nothing. That’s right, the total rate for I-bonds purchased for the next 6-month period is 0%, the Treasury Department announced yesterday.

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate. The 0.00% earnings rate for I bonds bought from May through October 2009 will apply for their first six months after issue. The earnings rate combines a 0.10% fixed rate of return with the -5.56% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). When the inflation rate is less than zero, a bond’s earnings rate is less than its fixed rate (but the earnings rate is never less than zero). The fixed rate applies for the 30-year life of I bonds purchased during this six-month period. The CPI-U decreased from 218.783 to 212.709 from September 2008 through March 2009, a six-month change of -2.78%.

The total rate of I-bonds is determined by a fixed rate plus a variable rate indexed to inflation. Even though the fixed rate is still positive at 0.10%, the -5.56% annualized variable rate brings the total rate down to zero (no negative rate though). This means that if you purchase any I-bonds in the next 6 months, you only buy the safety for your investments.

Well, it seems that one *good* thing the recession did for us so far is lower the inflation risk, but that’s not a good news for I-bond investors. Hopefully, the rate will go up when the next adjustment comes in November (I-bond rate is adjusted twice a year in May and November). If that’s case, then it also means the economic stimulus plan worked.

*Picture from WSJ

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I-Bond Rate for May 2009 – November 2009 Is 0%

4-Week T-Bill Pays 0% Interest Rate – Chart of The Day

Sun — Wed, 10 Dec 2008 03:21:39 +0000

Will you buy an investment that gives you zero return?

Under normal circumstance, I assume nobody will take such an investment. After all, investing is about return, right? Seeking return is what people normally do. However, now is not normal. Safety is on everybody’s mind. And when safety becomes the first priority, investors turn to U.S. Treasury securities, bills, notes, and bonds, which are seen that the safest investments.

The result?

Yields of Treasury securities are pushed to record lows, as we saw early with 10-year notes. Today, Treasury auctioned $40 billion 4-Week T-Bills at an interest rate of, well, 0%!

Can you imagine that? It looks like safety is the only concern investors have right now.

For once, 4-Week T-bill was one of my favorite short-term investments for its return, flexibility, and safety. But now, investing in 4-Week T-bill is like putting my money under the mattress, only safer

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4-Week T-Bill Pays 0% Interest Rate – Chart of The Day

I-Bond Rates for November 2008 – April 2009 Announced

Sun — Mon, 03 Nov 2008 17:27:50 +0000

Today, the Bureau of the Public Debt announced the interest rates for Series I-bond issued between November 2008 and April 2009. The total rate is set at 5.64%, including a fixed rate of 0.70% and an annualized rate of 4.92% adjusted based on the Consumer Price Index for all Urban Consumers (CPI-U).

The total rate of 5.64% may look impressive, but that’s not what you are going to earn through out the period, up to 30 years, when you hold the bond. Of the two components that determine the I-Bond earning rate, only the fixed rate, 0.70%, is what you are guaranteed to earn if you purchase I-Bonds from now till April 2009. The adjustable part, 4.92%, only lasts for 6 months and is subject to change when the Treasury releases the new rate next May. So if you buy I-Bonds now, the 5.64% rate is going to last till May 2009.

Since the I-Bond rates are tied to inflation, you will need to consider the overall inflation picture when making your purchase decision. The following is a plot of monthly CPI from 1997 to September 2008, based on data from Inflationdata.com.

As you can see, the CPI peaked in July when the price of crude oil approached $140 a barrel. Since then, the inflation has eased a little bit as oil price plunged more than 50% (the price of one gallon of regular gas in my area was $3.49 when I left for vacation and it’s $2.39 now). If the current economic slowdown continues, don’t expect a higher inflation based rate next May. How the fixed rate is determined? Nobody really knows because that the secrete of the Treasury. When they adjusted the I-Bond rate in May, the fixed rate went all the way down to 0.0% The 0.7% increase is nice, but nothing to get excited about.

Currently, I am still making monthly purchase of $100 of I-Bond. To me, that amount is enough, because I am not really looking at I-Bonds to protect against inflation.

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I-Bond Rates for November 2008 – April 2009 Announced