Financial Ratios and Statistics – FahStats

Archive for May, 2010

Unlike traditional bonds, saving bonds are not subject to the ups and downs of the stock market. Savings bonds are low risk, government-backed bonds with guaranteed rates of interest. There is a tax advantage to savings bonds because the owner may be able to partially or completely exclude their interest from Federal income tax.

There are three types of saving bonds: I, EE/E and HH/H. They are issued by the US Treasury Department. They can only be purchased in one of three ways: 1) through authorized financial agencies, such as a bank; 2) through payroll deductions; and 3) through an electronic service called TreasuryDirect. All saving bonds are registered and held in name of the person who owns them. Savings bonds are registered securities. They can be replaced if they are lost or destroyed.

Series I bonds are available at face value only. Series I bonds come in $50 to $10,000 denominations. No more than $30,000 (face value) of paper bonds and $30,000 of electronic bonds purchased each year. They must be held for a minimum of 1 year and they will accrue interest for 30 years. Interest on the Series I bonds is based on a fixed rate (announced by the Bureau of Public Debt in May of each year) and an annual inflation rate (announced in November of each year).

Interest is paid when the bond is redeemed. If this happens before the bond is five years old, there is an interest penalty equivalent to the three most recent month’s interest. Interest is not subject to State and local taxes. It is, however, subject to State and local estate, gift and other excise taxes. Interest on the bonds is also subject to Federal taxes. If the bonds are used to finance an education, all the interest or only part may be excluded from federal income taxes.

The series EE bonds replaced Series E. EE bonds are very affordable and can be purchased at one half of their face value. They come in denominations from $50 to $10,000. Individuals can buy no more than $30,000 (face value) worth of paper bonds and $30,000 of electronic bonds annually. EE bonds purchased between May 1997 and April 30, 2005 earn a variable market-based rate of return. Those issued May 2005 onwards earn a fixed rate of interest. They will generate interest for 30 years and the interest is compounded semi-annually. The Series EE bonds are similar to the Series I Bonds in regard to interest payment and time of redemption. The biggest difference between EE and I bonds is that interest rates are figured differently. EE Bonds receive 90% of 6-month averages of 5-year Treasury Securities market yields.

Prior to September 2004, Series HH savings bonds could be purchased only in exchange for Series EE/E bonds. After that date, they could be purchased without them. Series HH bonds are available in denominations ranging from $500 to $10,000. They are purchased at their face value. There is no limit on the amount that can be purchased.

The interest on Series HH bonds is fixed on the date of purchase and will continue to accrue for 20 years. The interest is deposited directly into the owner’s checking or savings account. Series HH Savings Bonds must be held for a minimum of six months. Like Series I and EE, the interest on Series HH bonds is not subject to State and local taxes. It is, however, subject and State and local inheritance, gift and other excise taxes.

Inflation-protected bonds (TIPS) are looking interesting these days. TIPS are bonds issued by the US Government that guaranty you a fixed return (usually around 2%) PLUS whatever inflation (CPI) turns out to be each year. These bonds are one of the safest investments you can make because there is very little or no credit risk (issued by the US government), liquidity risk (TIPS are heavily traded), or inflation risk. These TIPS bonds adjust their principal value and payout twice a year to compensate for any inflation.Hedge Against Rising Inflation
PIMCO’s Bill Gross, one of the most successful bond managers in decades, recommended inflation-protected bonds in early January 2009. “TIPS will benefit if and when the government’s efforts to reflate (the economy) begin to take hold.” These efforts to reignite the global economy will lead to faster inflation than is currently priced into the securities. Historically when the government has stomped on the monetary gas pedal to get the economy going by flooding the market with liquidity it has led to increased future inflation. TIPS bonds allow you to be hedged against the risk of rising future inflation. Inflation is one of the primary risks to a financially secure retirement. In my opinion TIPS inflation protected bonds are now extremely attractive relative to regular US treasury bonds which are in a “bubble” right now and will suffer if/when inflation concerns increase again. The “yield spread” between TIPS bonds and regular treasury bonds is now about the most extreme it has ever been (in favor of TIPS being more attractive).Hedge Against Deflation
Right now investors are more concerned about deflation (due to the very weak economy) than inflation, which is why these inflation-protected TIPS bonds are priced much more attractively than normal. TIPS are attractively priced now precisely because inflation expectations are low. You don’t want to buy flood insurance after the water is already in your home. By then, it is too late and the price of protection is too expensive. Many investors are unaware that these TIPS bonds are also a hedge against deflation because at expiration you get the accumulated principal value of the inflation adjustments or par value, whichever is greater. If there is massive deflation for years your “real” return after inflation/deflation would be very good because you would get the par value of the bonds at expiration. Maybe they should call these “Deflation-Protected Treasury Bonds”? The outlook for the economy is very uncertain right now. Will it rebound in the second half of 2009 resulting in rising inflation or will it continue to spiral downward causing deflation? It seems to me that TIPS could be pretty solid investments in either scenario. That is not true for most other investments.Great Portfolio Diversification Benefits
Another reason to consider adding inflation-protected treasury bonds (TIPS) to your portfolio is the powerful portfolio diversification benefits they bring. This reduces the overall risk and/or volatility of your portfolio over time. The returns on TIPS bonds have low or negative correlation with the returns of many other traditional investments such as stocks and regular bonds. The correlation of TIPS returns with the overall stock market (SP500 index) over the past years has been only 34%. Over longer periods of time the correlation of TIPS bond returns with the stock market and with traditional bonds has been close to zero. Rising inflation expectations are good for TIPS returns but in the short term are negative for the returns of stocks and bonds and vice versa.Best Ways to Invest in TIPS
I am a fan of exchange-traded funds (ETF’s) due to their very low costs and superior tax efficiency (and other reasons). The most liquid exchange-traded fund that invests in inflation-protected treasury bonds is the I-Shares (Barclays) fund with the symbol “TIP”. The expense ratio on this ETF fund is only .20%. The trailing 12-month yield on this ETF fund has been 6.46% (including the inflation adjustments). The Vanguard Inflation-Protected Securities (VIPSX) is a good low-cost index mutual fund (also a .20% expense ratio). As with all bond funds that pay out interest income, these funds are not very tax-efficient so they are better off held in a tax-deferred account (401K or IRA) if possible. The yield on these TIPS funds is currently about 2.5% (plus whatever inflation is going forward). You can also buy these TIPS bonds directly from the US treasury online.

When one speaks of budgeting, it is usually associated with the word management. In that same vein, the word financial is synonymous with money. Therefore by “financial budgeting” what we really mean is: money management. And Ladies and gentlemen, it is an art form.From the largest corporations to the forex traders to little Johnny Joseph who wants to buy his own I-Phone, proper financial budgeting is vital. For the most part it is all about planning and forecasting. No one can predict the future but forecasting helps to create a few scenarios of what lies ahead while planning makes the most of it. What I mean by that is that if you anticipate loss in one area, you can compensate by earning more or cutting costs to meet the challenge.Of course at the corporate levels, there are obviously a handful of professionals whose job it is to do the financial budgeting. It does not mean that an individual cannot do an excellent job for him or herself on a smaller scale with a little bit of guidance and learning Before anything else you must have a handle on two things: the plus and the minus. That is what is coming into your accounts and what is going out. That is the first part of financial budgeting.You can do this one of two ways: You can either start tracking your expenses and your earnings over the period of a month, or you can make an estimate based on your experience. Of course, the former is a more accurate way to assess your situation, but if time is of the essence, the latter is OK as long as you can be accurate. The goal here is to end up in the “green” so to speak. Sadly, this is not the case for most people. The majority of people in the western world spend more than they earn, living off credit and never becoming debt free. This does not have to be you. With proper financial budgeting and some logical steps you can change your situation.This is why I suggest writing everything down to start off with, so that you have a visual of your situation, your expenses etc. You would be amazed at the number of areas where you could be saving money and applying it to something positive like a retirement fund or getting rid of those credit card debts.It is important to understand that financial budgeting is a work in progress. The nature of your budget changes as the factors that make up the balance sheet change. This could be due to changes in the economy, to your job and household income; it could even be the result of lower heating bills due to climate change. You have to be wise about this and learn to forecast to the best of your ability. The most important thing however is this: No matter what, always pay yourself a little something as well. Put something aside for the future because you never know when that rainy day will come.