watchnerd wrote: ↑Wed Apr 21, 2021 11:48 am
But I struggle with how to evaluate EE returns in real terms.
I can offer three perspectives.
1. As a CA resident with a high tax rate, I evaluate EE Bonds this way.
ER = 0.0% (No money lost to ER.)
Non Marketable = As EE Bonds are not traded, the market environment won't impact an EE Bond investment
20 year Return = 3.526% paid at 20 years, guaranteed by US Treasury
20 year Tax Equivalent Yield at a 9% CA Tax rate is 3.526%/.91 which = a 3.87% Tax Equivalent Yield for Californians in high tax brackets
Main Risk = Whatever average inflation is over next 20 years will impact the real yield of the EE Bond (what you earn after inflation.) So 2% average inflation over the next 20 years means you will get a 1.87% real tax equivalent yield assuming you are paying 9% CA State Tax. Like many EE Bond Investors, I would take that. (It would mean that EE Bonds beat I Bonds, which I also purchase, over the same period.) In the case of 20 years of 3.87% average inflation the EE Bond returns 0% real yield, neither losing or gaining the investor anything. And anything greater than 3.87% average inflation means a negative real yield, and that is where I Bonds begin to surpass EE Bonds. (In the latter scenarios, however, you'd likely be looking at point 3 below about Yield to Maturity and Selling EE Bonds.)
Of course, this can also work the complete other way if inflation is very low or we have deflation. In that case current EE Bonds would be
very desirable.
2. Another way to think about it is to calculate what it would look like if EE Bonds paid their interest in an annual coupon.
They
don't, to be clear. You have to hold EE Bonds for 20 years to get the cumulative yield below. However, even from year one, it's clear that aside from I Bonds, few current Fixed Income investments are paying $358.25 per $10,000 in your first twelve months. This is one way to look at it. (However, note that the final return, calculated using an online calculator, might end up a few dollars more generous in year 20 due to compounding interest.)
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1 $10,000.00 $358.25
2 $10,358.25 $371.11
3 $10,729.34 $384.39
4 $11,113.72 $398.16
5 $11,511.87 $412.43
6 $11,924.28 $427.19
7 $12,351.47 $442.49
8 $12,793.96 $458.33
9 $13,252.31 $474.77
10 $13,727.07 $491.77
11 $14,218.85 $509.39
12 $14,728.24 $527.62
13 $15,255.88 $546.54
14 $15,802.42 $566.12
15 $16,368.55 $586.40
16 $16,954.95 $607.43
17 $17,562.37 $629.18
18 $18,191.54 $651.73
19 $18,843.25 $675.06
20 $19,518.32 $699.24 $20,217.56
(Interestingly for CA investors in high tax brackets, I'm currently seeing distribution payments of around $229 per year for $10,000 in CA LT Muni Bonds after fees (
VCITX) which is the Tax Equivalent a 3.52% yield for someone with a Fed + State 35% Tax Rate. (2.29%/.65= 3.52%) And for higher tax brackets, the tax equivalent yield of CA LT Muni Bonds in VCITX
currently beats EE Bonds. However, CA LT Munis are a very different Fixed Income investment from EE Bonds in that they involve the risk of investing in Investment Grade Municipal Bonds from a single state.)
3. EE Bond Options: Since EE Bonds are not marketable, EE Bond investors can sell at any point with 100% of principal recouped, and miniscule tax impact, if a product with a better yield to maturity emerges. So, if at 10 years, a 10 year Treasury bond with a rate of 7.2% is on offer, you can feel free to sell your EE Bond and purchase the 10 year Treasury, and you will beat EE Bonds since neither pay state tax. You can use the chart below to make up your mind about selling your EE Bonds, or whether you would likely do so at a certain point, regardless.
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Year Balance YTM Ratio YTM
0 $1,000 1.0353 2.0000 3.526%
1 $1,001 1.0371 1.9980 3.710%
2 $1,002 1.0391 1.9960 3.914%
3 $1,003 1.0414 1.9940 4.143%
4 $1,004 1.0440 1.9920 4.401%
5 $1,005 1.0469 1.9900 4.695%
6 $1,006 1.0503 1.9880 5.031%
7 $1,007 1.0542 1.9861 5.420%
8 $1,008 1.0588 1.9841 5.876%
9 $1,009 1.0642 1.9821 6.417%
10 $1,010 1.0707 1.9801 7.070%
11 $1,011 1.0787 1.9781 7.874%
12 $1,012 1.0889 1.9762 8.887%
13 $1,013 1.1020 1.9742 10.204%
14 $1,014 1.1198 1.9722 11.985%
15 $1,015 1.1453 1.9702 14.526%
16 $1,016 1.1845 1.9683 18.446%
17 $1,017 1.2528 1.9663 25.281%
18 $1,018 1.4015 1.9643 40.155%
19 $1,019 1.9624 1.9624 96.238%
I may not have persuaded you that EE Bonds are right for you, but I hope you can see what they do and don't deliver, and what the particular risks and benefits of EE Bonds are.