Sell I bonds to purchase TIPS after rate reset?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
patrick
Posts: 2589
Joined: Fri Sep 04, 2009 3:39 am
Location: Mega-City One

Sell I bonds to purchase TIPS after rate reset?

Post by patrick »

I currently hold various I bonds with real yields between 0% and 0.5%. Real yields on 10-year TIPS are now 0.98%, and they are even higher at other maturities.

Right now, my I bonds are using an inflation rate of 9.62% annualized (based on the inflation rate from September 2021 to March 2022, if I understand correctly) which seems to make them worth keeping regardless. However, one would certainly hope that the inflation rate does not turn out that high for the next period, which would mean that the interest rate on would drop after the new rate is applied. Most of my I bonds were issued in January and thus would reset to the new rate in January.

I bonds do have the advantage of avoiding state taxes and deferring federal taxes. However, if I sold them I would then buy stocks in the taxable account and shift stocks to TIPS in my retirement accounts. Some of my gains would still be deferred, and nearly all would get the lower 15% rate, so the tax benefit isn't useful to me.

I bonds also have the advantage of a 0% floor on nominal returns, giving them a boost if there is deflation over any 6-month period. While that's not something many of us are thinking about today, it could well happen once in the next 25 years.

Which all raises a couple of issues regarding the decision whether to sell:

1) How much is the deflation protection worth? In the 24 years I bonds have been available there have only been 2 semiannual deflations, -0.8% calculated May 2015 and -2.78%. An I bond with zero real rate would have only come out 3.7% higher with the deflation protection, or about 0.15% on an annualized basis, with a smaller benefit if the real rate were higher than zero. If I simply added 0.15% to the I bond rate before making the comparison, TIPS would still come out significantly ahead at current rates.

2) How high would the semiannual rate need to be to justify holding the I bonds even with a worse real yield? It seems like the current 9.62% is sufficient, but how about 7% or 5%? If threshold is low enough, this risks staying in lower-yielding I bonds for a long time if elevated inflation persists.
User avatar
Admiral Fun
Posts: 286
Joined: Mon Jun 04, 2012 8:04 pm

Re: Sell I bonds to purchase TIPS after rate reset?

Post by Admiral Fun »

Good question! I hope some of the Bogleheads bond experts bite on this one.
User avatar
grabiner
Advisory Board
Posts: 35265
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Sell I bonds to purchase TIPS after rate reset?

Post by grabiner »

The proper basis for comparison is not the raw rate, but the inflation lag. If the inflation lag means that an I-bond has an annual rate of 4% for the next six months (based on the past six months' inflation) and a TIPS has an annual rate of 3% (based on its current yield and projected inflation for those six months; you could use nominal Treasury yields to project the rate), then it's worth holding the I-Bond rather than switching to TIPS. Even if the rates are equal, you might prefer keeping the I-Bond because this gives you more tax deferral, and retains the option to keep the I-Bond again in the future and continue to get tax deferral.
Wiki David Grabiner
Post Reply