Ibond SWR calculations

[electriceagle]

Has anyone (anyone reputable) done the calculations to determine the SWR for an 80/20, 70/30, or 60/40 portfolio with zero-fixed-rate Ibonds as the bond component?

I realize that the $10k/15k annual purchase maximum and inability to put them inside retirement accounts are serious limitations, and that Ibonds have not existed for very long, but I am curious about whether making them the bond component changes the 4% SWR substantially.

[ChpBstrd]

That would be a complicated calculation, due to the constantly fluctuating yield, which changes twice per year. You could hack the SWR calculation spreadsheet available on earlyretirementnow.com with a formula for an alternative asset return involving CPI + some small amount. That's probably as close as you'll get.

Historically, people with a 4% WR had to worry about 2 episodes: The Great Depression and the late 1960s right before the inflation of the 70's and 80's. Ibonds would have been a brilliant investment if they had existed in the late 1960s, but of course would have been regrettable in the deflationary Great Depression.

More to the point, in normal times regular treasuries reflect the inflation rate plus a small premium. We are in very odd times now because treasuries are yielding far less than inflation. This situation of 9% CPI and 3% 10y treasury yields has literally never happened before in the U.S. which is why people are suddenly so excited about Ibonds. Owning inflation-linked bonds is a horrible idea if your sequence of return event is destined to be a deflationary recession/depression, but it's a great idea if your SORR event is going to be a decade of inflation. Maybe an optimal solution to cover both risk scenarios would be something like a 50/50 mix of regular and inflation-indexed treasuries. But in a return-to-normal scenario, there wouldn't be a big gap between CPI, regular treasuries, and Ibonds like there is today.

[bacchi]

iBonds and TIPS haven't been around long enough for any real SWR analysis. The TIP ETF goes back to 2003 and individual TIPS go back to the late 90s.

[wageslave23]

This is a quick analysis, but I think you would take the amount in ibonds divided by years of retirement and that would give you the safe withdrawal.  Because Ibonds only keep up with inflation, and your withdrawal grows with inflation.  So there is no net growth or loss compared to your withdrawal. 

Then figure out the safe withdrawal rate for the rest of your portfolio.  If you want, you can weight the two rates based on percentage allocated to ibonds to find your overall swr.  But I bonds in general are very simple 100/yrs of retirement= swr.

[bacchi]

This is a quick analysis, but I think you would take the amount in ibonds divided by years of retirement and that would give you the safe withdrawal.  Because Ibonds only keep up with inflation, and your withdrawal grows with inflation.  So there is no net growth or loss compared to your withdrawal. 

Then figure out the safe withdrawal rate for the rest of your portfolio.  If you want, you can weight the two rates based on percentage allocated to ibonds to find your overall swr.  But I bonds in general are very simple 100/yrs of retirement= swr.

Good point. They can be handled differently.

So $100k in iBonds over 30 years is $3333/yr.

If you need $40k/yr, you'd need to withdraw $36667/yr from your other assets. What is the SWR of your other assets with a $36667 withdrawal?

It looks like iBonds would require a slightly larger total portfolio than the typical asset allocation. It might, however, reduce SORR.

[mistymoney]

my question is have any particular flavor of bonds gone through this kind of testing?

I only ever see "bonds. generic bonds."

but I don't get too twisted up in that. I'm not a bond girl in the slightly.

[clifp]

I think iBonds are overhyped as a tool for early retirement saving.
Even if you could get around the purchase limitations, with a current coupon rate of 0%, we know that the SWR of 100% portfolio of ibonds would be 3.33% for a 30 year retirement. We also know that you would run out of money in year 31.  That's not a big deal if you retire at 65, in your 40s it is a huge deal.

I think the best way of thinking about iBonds is a short-term "hack" that will net you a $200-$300 in additional interest/year.  The relative performance benefits of ibonds over other fixed income choices will likely last only a few years.  I last bought ibonds in 1999/2000 when the coupon rate was >3%.  I also bought them last year and this year.  During the 20-year gap between purchases, I would periodically check on them.  Before this year, there was never a compelling case to buy them.

[wageslave23]

I think iBonds are overhyped as a tool for early retirement saving.
Even if you could get around the purchase limitations, with a current coupon rate of 0%, we know that the SWR of 100% portfolio of ibonds would be 3.33% for a 30 year retirement. We also know that you would run out of money in year 31.  That's not a big deal if you retire at 65, in your 40s it is a huge deal.

I think the best way of thinking about iBonds is a short-term "hack" that will net you a $200-$300 in additional interest/year.  The relative performance benefits of ibonds over other fixed income choices will likely last only a few years.  I last bought ibonds in 1999/2000 when the coupon rate was >3%.  I also bought them last year and this year.  During the 20-year gap between purchases, I would periodically check on them.  Before this year, there was never a compelling case to buy them.

This is correct.  They are good for emergency funds and not much else. They will soon return to 2 to3% and only keep up with inflation. Most people expect to beat inflation by several percentage points.

[Johnny72]

So looking for advice for my position. Just got 150k fro
 sale of rental house. Thinking that beyond tax effective investments ibonds for me and partner are next on the list with bear market and inflation. Any other ideas for cash preservation with inflation protection?

[Radagast]

I think iBonds are overhyped as a tool for early retirement saving.
Even if you could get around the purchase limitations, with a current coupon rate of 0%, we know that the SWR of 100% portfolio of ibonds would be 3.33% for a 30 year retirement. We also know that you would run out of money in year 31.  That's not a big deal if you retire at 65, in your 40s it is a huge deal.

I think the best way of thinking about iBonds is a short-term "hack" that will net you a $200-$300 in additional interest/year.  The relative performance benefits of ibonds over other fixed income choices will likely last only a few years.  I last bought ibonds in 1999/2000 when the coupon rate was >3%.  I also bought them last year and this year.  During the 20-year gap between purchases, I would periodically check on them.  Before this year, there was never a compelling case to buy them.

This is correct.  They are good for emergency funds and not much else. They will soon return to 2 to3% and only keep up with inflation. Most people expect to beat inflation by several percentage points.

In isolation, you are correct that they don't add much, but a 5%-10% allocation would have saved your bacon in a few of those 5/100 years where stocks and regular bonds failed the 4% rule (had they existed).

As part of a bond portfolio they are more useful. They have unusually high return relative to their non-existent risk, and their duration can be anything you want in the 1-30 year range as is most convenient at the time, which is a very powerful option. The allow you to take more duration or credit risk with your other bonds and end with a higher rate of return for the same degree of risk, which means they are actually better than regular bonds.

[clifp]

In isolation, you are correct that they don't add much, but a 5%-10% allocation would have saved your bacon in a few of those 5/100 years where stocks and regular bonds failed the 4% rule (had they existed).

As part of a bond portfolio they are more useful. They have unusually high return relative to their non-existent risk, and their duration can be anything you want in the 1-30 year range as is most convenient at the time, which is a very powerful option. The allow you to take more duration or credit risk with your other bonds and end with a higher rate of return for the same degree of risk, which means they are actually better than regular bonds.
[/quote]

You are correct today. My point is that the relative outperformance of iBonds to other bonds is temporary and quite unusual in the history of iBonds. So for example back in 99 and 2000 when bought ibonds coupon rate of 3.4% I was able to buy 10 year TIPs bonds with a coupon rate of 3.9%, also with no credit risk and no $10K limitation.  In the mid 2005s, I bought a bunch of Sallie Mae inflation adjusted bonds with durations around 10-years, with a coupon rate more than 2% over the iBonds rate, albeit with moderate credit risk.

I'm not saying don't buy iBonds now, you should.  Just don't count on ibonds always being the no brainer they are today.

[ChpBstrd]

Another take on I-bonds or TIPS is that they can offset your annual increase in spending due to inflation. For example, suppose inflation is 10% and you are in your first year of FIRE with a $50,000 WR. The next year, you will have to spend $55,000. The third year $60,500.

Now suppose you started FIRE with $100k in I-bonds plus TIPS in your portfolio, an 8% AA for a 25x portfolio . Your I-bonds (assuming you bought with a 0% fixed rate like today) will pay 10% interest and reinvest that amount into the bond. Your TIPS will increase the principal value by 10% and continue paying their interest (usually a fraction of 1%) on the newly adjusted principal - for simplicity let's say they gain 10% in value each year too*. To make the TIPS comparable to your I-bond allocation, let's assume you reinvest all TIPS interest payments. Either way, and roughly regardless of how many I-bonds vs. TIPS you have, your $100k asset allocation to inflation-adjusted bonds increases alongside your increases in spending:

Year     Spending     Approx Value of Inflation-Adjusted Bond Portfolio     
1          $50,000       $100,000
2          $55,000       $110,000
3          $60,500       $121,000
4          $66,550       $133,100
5          $73,205       $146,410

Cumulative spending over $50k/year due to inflation: $55,255
Increase in value of inflation-adjusted bond portfolio: $46,410

So you hedged 84% of the damage from five years of 10% inflation that hit at the worst possible time right at the beginning of early retirement with only an 8% asset allocation to inflation-adjusted bonds. You are still probably in deep shit because I don't imagine the rest of your portfolio did so hot in a world of 10% inflation that lasted for 5 years, but you at least hedged your drawdowns during that time, and in this scenario you're probably again at that early-1980s point where stock indices had single-digit PE's or you could just buy treasuries yielding 15% or so. So maybe NOW your safe withdraw rate is something like 8% or 9%.

Also, in a world of 10% inflation it is likely you'd be moving some assets into I-bonds during retirement at a pace of $10k/person per year. Just like now, that would be too good a deal to pass up. So maybe by year 5 you have allocated another 4% of your portfolio to I-bonds.
 
With the Federal Reserve showing signs of doing too little too late, maybe now is the time to implement such a plan to cover the contingency risk of high inflation. Then you use options strategies like protective puts and collars to mitigate the risk of your stock portfolio falling below a certain level. There's no simple way to model any of this stuff, but these strategies together seem to address most of the failure cases of the 4% rule: unexpected inflation and unexpected depression.

*in reality it seems TIPS have a fixed yield that is higher than I-bonds fixed yield. This is to compensate investors for the additional risk that TIPS have; their principal value can go down if deflation occurs, but I-bond interest cannot go negative.

[electriceagle]

my question is have any particular flavor of bonds gone through this kind of testing?

I only ever see "bonds. generic bonds."

but I don't get too twisted up in that. I'm not a bond girl in the slightly.

Dammit, Moneypenny. Goldfinger was expecting a little more interest from you.

[electriceagle]

I think iBonds are overhyped as a tool for early retirement saving.
Even if you could get around the purchase limitations, with a current coupon rate of 0%, we know that the SWR of 100% portfolio of ibonds would be 3.33% for a 30 year retirement. We also know that you would run out of money in year 31.  That's not a big deal if you retire at 65, in your 40s it is a huge deal.

I think the best way of thinking about iBonds is a short-term "hack" that will net you a $200-$300 in additional interest/year.  The relative performance benefits of ibonds over other fixed income choices will likely last only a few years.  I last bought ibonds in 1999/2000 when the coupon rate was >3%.  I also bought them last year and this year.  During the 20-year gap between purchases, I would periodically check on them.  Before this year, there was never a compelling case to buy them.

I'm thinking of them as a replacement for a typical bond fund in a 80/20, 70/30, or 60/40 stock/bond portfolio, not as a standalone retirement savings vehicle.

Even though ibonds did not exist decades ago, one could run a simulation using bonds that follow the ibond rules.

[Radagast]

You are correct today. My point is that the relative outperformance of iBonds to other bonds is temporary and quite unusual in the history of iBonds. So for example back in 99 and 2000 when bought ibonds coupon rate of 3.4% I was able to buy 10 year TIPs bonds with a coupon rate of 3.9%, also with no credit risk and no $10K limitation.  In the mid 2005s, I bought a bunch of Sallie Mae inflation adjusted bonds with durations around 10-years, with a coupon rate more than 2% over the iBonds rate, albeit with moderate credit risk.

I'm not saying don't buy iBonds now, you should.  Just don't count on ibonds always being the no brainer they are today.

It's unusual in the history of Ibonds, but not in the history of bonds though. They would have done as well or better in 1965-1982. Anytime bonds lost value in real or nominal terms over a period longer than 5 years, and in many cases longer than 1 year, Ibonds would have been better. Plus the tax advantages, choose-your-own-duration, and others discussed repeatedly, and they have consistently had yield greater than their non-whatsoever risk. Particularly as as a barbell for some riskier bonds.

[waltworks]

If we're using the Trinity Study rules (ie, 30 year retirement, balance >0 at the end is a success) then the SWR is 3.33%, given that you'd draw down 1/30 of the inflation-proof iBonds each year.

Accumulating a large enough pile of iBonds to do actually this would be tricky, of course. I think we've got about $200k now but we'll probably cash out if/when rates drop below 4-5% or so. At that point I'd rather own stocks and just let it ride.

As part of a more diverse portfolio I'd model them as a sort of super-cash. They don't function for rebalancing (though lately neither do other bonds) with stocks, really, but if you're really conservative or want/need to have a lot of cash on hand for whatever reason they're great. "Dry powder" without the inflation drag.

-W

[ChpBstrd]

If we're using the Trinity Study rules (ie, 30 year retirement, balance >0 at the end is a success) then the SWR is 3.33%, given that you'd draw down 1/30 of the inflation-proof iBonds each year.

To actually increase one's spending at the rate of inflation, one would have to never buy a home and always rent, replace their old things with new things every year to capture the increase in prices, never adjust consumption of anything no matter how high the price, never grow a vegetable, and never improve the efficiency of anything like their home, car, financial helpers, etc. Keeping up with CPI would require a very intentional lifestyle.

[wageslave23]

If we're using the Trinity Study rules (ie, 30 year retirement, balance >0 at the end is a success) then the SWR is 3.33%, given that you'd draw down 1/30 of the inflation-proof iBonds each year.

To actually increase one's spending at the rate of inflation, one would have to never buy a home and always rent, replace their old things with new things every year to capture the increase in prices, never adjust consumption of anything no matter how high the price, never grow a vegetable, and never improve the efficiency of anything like their home, car, financial helpers, etc. Keeping up with CPI would require a very intentional lifestyle.

I'm not following.  If you own your home, then your expenses are taxes, utilities, insurance, and maintenance.  Those expenses would need to keep up with inflation. If you have a fixed rate mortgage, then sure that will not keep up with inflation.  But that's about the only fixed budget amount that won't increase with inflation. If you have say a $40k a year budget, I would expect the majority of those expenses to be susceptible to inflation.  Some more, some less than average inflation.

[waltworks]

Yeah, even if you eat only scavenged food and ride your bike everywhere and have a 30 year fixed mortgage, you still have expenses that will mostly track inflation. Your computer or phone or pants won't last forever and you'll eventually need new ones.

-W

[ChpBstrd]

If we're using the Trinity Study rules (ie, 30 year retirement, balance >0 at the end is a success) then the SWR is 3.33%, given that you'd draw down 1/30 of the inflation-proof iBonds each year.

To actually increase one's spending at the rate of inflation, one would have to never buy a home and always rent, replace their old things with new things every year to capture the increase in prices, never adjust consumption of anything no matter how high the price, never grow a vegetable, and never improve the efficiency of anything like their home, car, financial helpers, etc. Keeping up with CPI would require a very intentional lifestyle.

I'm not following.  If you own your home, then your expenses are taxes, utilities, insurance, and maintenance.  Those expenses would need to keep up with inflation. If you have a fixed rate mortgage, then sure that will not keep up with inflation.  But that's about the only fixed budget amount that won't increase with inflation. If you have say a $40k a year budget, I would expect the majority of those expenses to be susceptible to inflation.  Some more, some less than average inflation.

Yeah, even if you eat only scavenged food and ride your bike everywhere and have a 30 year fixed mortgage, you still have expenses that will mostly track inflation. Your computer or phone or pants won't last forever and you'll eventually need new ones.

-W

Things like staplers, wrenches, cast iron skillets, quality furniture, decor, and even some clothing can last for an entire retirement. If you buy them once and manage not to lose them, you might never have to buy them again. Thus you are immune to price increases for those things. Similarly if you have 30 years to live, and install a 30 year roof on your house, you will never pay a higher price to have a roof. If you invested in home remod projects that will last 30 years, it's the same thing. I've had a London Fog down coat for 22 years now, and it is still in good shape.

Sure there are lots of disposable items like electronics, toiletries, appliances, cars, shoes, etc. but every elderly person I know has a house full of old-but-functional stuff they bought when they were working and never have to purchase again. Many of them have also added insulation to their houses, upgraded to more efficient appliances, and applied their free time to growing their own veggies.

In terms of cars, when one no longer has a commute, one's car lasts maybe 14 years instead of 7. Buying and mostly depreciating a car once every 14 years has a much different cost structure than wearing out a car every 7 years. Much more time is spent in the flat depreciation years than in the fast depreciation years. And that's not even accounting for the reduced vulnerability to fuel prices or the option to go liability-only on the car insurance during the car's later years.

[TomTX]

Historically, people with a 4% WR had to worry about 2 episodes: The Great Depression and the late 1960s right before the inflation of the 70's and 80's. Ibonds would have been a brilliant investment if they had existed in the late 1960s, but of course would have been regrettable in the deflationary Great Depression.

In a deflationary period like the Great Depression, Ibonds would behave like cash. The interest rate can't drop below zero and you never lose principal. I don't think many people would think rolling into the Great Depression with a big pile of cash would be regrettable.

[Radagast]

Historically, people with a 4% WR had to worry about 2 episodes: The Great Depression and the late 1960s right before the inflation of the 70's and 80's. Ibonds would have been a brilliant investment if they had existed in the late 1960s, but of course would have been regrettable in the deflationary Great Depression.

In a deflationary period like the Great Depression, Ibonds would behave like cash. The interest rate can't drop below zero and you never lose principal. I don't think many people would think rolling into the Great Depression with a big pile of cash would be regrettable.

Hadn't seen this quote, but yes. I-bonds are actually more powerful against deflation even though that is not what they are famous for. If inflation is -1%, they will give a +4.33% SWR.

[blue_green_sparks]

I read that I-bond rates are probably gonna return from 6-8% next period. If we buy one before Nov, we are looking at an APR of AVG[9.62:6-8] or 7.8 to 8.6% for year 1. I'm bought-out this year, so I'll go ahead with a gift bond and take the risk that year 2 of its returns will probably be lower.

[blue_green_sparks]

I read that I-bond rates are probably gonna return from 6-8% next period. If we buy one before Nov, we are looking at an APR of AVG[9.62:6-8] or 7.8 to 8.6% for year 1. I'm bought-out this year, so I'll go ahead with a gift bond and take the risk that year 2 of its returns will probably be lower.

So we'll have 6.5% for November. Just a few days left to lock in an 8%APR i-bond.

[bacchi]

I read that I-bond rates are probably gonna return from 6-8% next period. If we buy one before Nov, we are looking at an APR of AVG[9.62:6-8] or 7.8 to 8.6% for year 1. I'm bought-out this year, so I'll go ahead with a gift bond and take the risk that year 2 of its returns will probably be lower.

So we'll have 6.5% for November. Just a few days left to lock in an 8%APR i-bond.

Sadly, buying gift bonds is broken right now at TD.

[waltworks]

I read that I-bond rates are probably gonna return from 6-8% next period. If we buy one before Nov, we are looking at an APR of AVG[9.62:6-8] or 7.8 to 8.6% for year 1. I'm bought-out this year, so I'll go ahead with a gift bond and take the risk that year 2 of its returns will probably be lower.

So we'll have 6.5% for November. Just a few days left to lock in an 8%APR i-bond.

If I had the free cash I'd buy some that I couldn't deliver as gifts until 2024...already filled up the 2023 gift pile.

-W