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I'm mainly interested in a finding a medium-term, low risk savings vessel. Bank and Credit Union savings accounts available to me at the moment are all < 1% APY, so inflation-protected securities are attractive to me right now.

First of all, it would be helpful if someone could clarify the difference between TIPS and I-Bonds. There are 3 previous questions on this site tagged with TIPS. There is no separate tag I can find for I-Bonds, although there seem to be a few questions and answers that fit them. The Treasury site has this helpful comparison between TIPS and I-Bonds, but doesn't answer some fundamental questions.

  1. Are I-Bonds a type of TIPS?

They're Treasury issued and somewhat inflation protected and they're a bond, so a type of financial security. Is this just a case of overlapping names? Naming things is hard.

  1. Are I-Bonds earnings & interest superior to TIPS?

TIPS imply that they can go down if deflation occurs. Can I-Bonds ever depreciate in value? Also, I-Bonds impose buying limits per person and appear to be non-transferable, implying they have significant benefits over the unlimited, transferable TIPS, which also seem to be available through 3rd-party investment funds.

  1. Do TIPS and I-Bonds rate fluctuate over the term of the bond?

The current rate for I-Bonds seems to be 1.48% while TIPS recently auctioned for a max of 0.842%. I understand that the two account for inflation in different ways: I-Bonds vary the rate while TIPS vary the principle. How much of this is 'locked in' when I purchase the bond for each? Or are both capable of losing money if significant deflation occurs?

  1. If I want to hedge some savings against inflation, should I own both I-Bonds and TIPS?

Alternatively, should I buy I-Bonds up to the $10k/year limit and only put excess in TIPS?


Now, what I'm thinking of doing is putting a portion of my cash savings into I-Bonds every year. This savings is currently a small (admittedly undersized) emergency fund that I would like to grow. I've just paid off some credit card debt so I have some funds to start a new investment. Psychologically though, I have hard time justifying growing a savings when the interest rate is so low.

Since I-Bonds are not redeemable for 12 months, I obviously wouldn't want to tie all my emergency funds up in it right away. If I were to gradually move the account to I-Bonds, similar to a CD Ladder, would that be able to double as an emergency fund (fixed dollar amount equal to 3-6 months living expenses) and long-term cash savings (10-20% of non-retirement investments)? Would TIPS be a better vessel for this strategy?

If you don't think that's not a good use of I-Bonds, then where would I-Bonds and TIPS fit into your investment portfolio?

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tl,dr: I-bonds do not fit well into most personal finance plans.

First the questions (succinct reference):

  1. No. The names are weird I agree. I-Bonds are not really securities as they are not tradable.
  2. (a) No, in general investors do not get competitive yield from I-Bonds when everything is adjusted for. You note the interest rate for I-Bonds is higher, but the inflation is factored into the principal of TIPS not the interest rate so this is not a great comparison. Technically, I-Bonds can't ever depreciate in value as you can't resell I-Bonds they have no traded price/value. However, they can be worth less to you portfolio in future earnings if inflation drops.
  3. I-Bonds have a fluctuating rate. TIPS have a constant rate, but a fluctuating yield (effective rate) as the price and principle amount both change from the original price and principle.
  4. No, you should generally own some combination of TIPS, bonds, equity and perhaps commodities.

I like your thought process weighing your liquidity and risk versus your return. This is very important. However, I think you might be sidetracked a bit by I-Bonds. I-Bonds are not generally good for personal investment as they are not marketable when necessary, have redemption penalties and hold lower overall yields in general. Finally, they are significantly harder to trade as you can buy and hold a TIPS ETF and get exposure to all maturities and get the current competitive rate all in one purchase.

Inflation protection is in general an interesting problem. While inflation-protected bonds sound like they are great for inflation protection (after all it is in the name), they may not be the best instruments for long/medium term protection. It is really important to remember that inflation protected bonds have significantly lower returns and one form of inflation protection is to just have more money in the future. TIPS really protect against large inflation changes as normal bonds have the future expected inflation already baked in their higher rates.

Also, when you own a stock you own part of a company and inflation will increase the value of the company relative to the inflated currency. Foreign stocks can give even more protection if you think inflation in your local currency is going to be higher then the foreign currency. Stocks in the past have had significantly higher return overall than inflation protected bonds but have higher risk as well.

As a medium term, low-risk portfolio, it is worth looking into some combination of TIPS, normal bonds and a small to medium allocation of local/foreign stocks all done through low-fee mutual funds or index ETFs.

  • So would a better name for I-Bonds be deflation-protected securities? Or does the negative inflation-rate on this table for May 1, 2009 mean that I-Bonds can still decrease in value if deflation strikes? – Dacio Mar 3 '15 at 22:25
  • Also, I had assumed that electronic I-Bonds would be easy to redeem. In theory, you just log into the treasury website and sell them, provided its after the 12 month initial period and you're willing to lose the last 3 months of interest. This is no worse than getting a long-term CD cashed at a typical bank or credit union (and somewhat better, if the respective interest rates hold). Your answer implies it's significantly harder than that to get your money out of an I-Bond. – Dacio Mar 3 '15 at 22:27
  • They are still inflation protection in general though they do have the interesting feature of having an interest rate (fixed + inflation) floor at 0% that TIPS don't have. so they have minimal protection from very low interest rates in combination with inflation rates. But at best this is a temporary difference between 0 and a small negative number. Neither looks good from a medium-term investment perspective. – rhaskett Mar 3 '15 at 22:44
  • They are easy to buy/redeem. The (relative) difficulty is in upkeep. You can buy a single TIPS ETF (instead of individual TIPS), add money to it, take money out ect and pay a small amount of fees, but any way you need only one instrument and that security always right near at the current market price. The I-bonds you would have to buy many different instances of I-bonds at different fixed rates making sure that they aren't too much lower than the TIPS rate. Roll in and out of them. Take the interest rate hit if you need to pull out early... – rhaskett Mar 3 '15 at 22:50
  • That is no worse than CD chaining, probably better actually, but why chain at all? – rhaskett Mar 3 '15 at 22:52

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