Is the Stock Market Safe Again?

Ten! Nine! Eight! Seven! Six! Five! Four! Three! Two! One! HAPPY NEW YEAR! (Am I late? Sorry about that.) WELCOME TO 2003!

FLEETING BLISS

John Seiffer: ‘It’s now 01/02/03 at 04:05.’

BIG TV

David and Hans: ‘We think you are wise to wait on the Plasma TV. The Plasma is an energy guzzler and has a very high drop off rate. The picture quality gets worse with each hour of use. We are waiting for the LCD TVs to get bigger. They use practically no energy and you don’t have to worry about losing your pixels.’

MORE FREE MONEY

Tom Kirby-Smith: ‘I just picked up the latest edition of your Investment Guide and found out you can buy Series I inflation protected U. S. Savings bonds using a credit card. Now Fleet bank has given me an interest-free credit line of $20,000 until next August (as long as I make small monthly payments just to prove I am still alive, I guess). The Series I bond is paying better than 4%. You lose three-months’ interest cashing it in early. So if I buy $20,000 worth, cash them all in after six months, pay off the credit card, I get $200. What is wrong with this scenario? For that matter, how about I go out and get a 15-year $100,000 mortgage at 5.5%? It’s deductible, making it a real interest rate of about 3.5%. I buy $100,000 of Series I bonds and collect better than 4% interest that accumulates tax free. So I get paid $500 to hold $100,000 – and if inflation increases, so do my interest payments. At 6% inflation I start accumulating a profit of $2,000 a year tax free. There ought to be a law against this, and I am sure there is, but it’s just fun to think about.’

☞ Yes and no. The first part – borrowing for 0% on a promotional credit card offer – should work OK if you’re careful and don’t accidentally make a late payment and trigger the ‘regular’ rate. I-Bonds are currently pegged to pay just 1.6% on top of inflation, and inflation is running very low. (Indeed, deflation is today’s worry.) But the current combined rate of 4.08% will be paid through May, even though you would lose half of it if you cashed the bonds in after six months (and would then have to pay tax on the rest).

MBNA just called today to see if I wanted yet another zero percent card – this one with 12 months free interest. This cannot end well for the shareholders of MBNA, if you ask me; but it is certainly nice for us consumers. In your case, if you could find a deal like this, you’d earn interest on 9 of the 12 months after the penalty for cashing them in early. (Under the heading of Life Is Unfair – or at least the heading The Rich Get Richer – the best deals, like this one, are offered to those who need them least. So I don’t think you can actively ‘look for’ a deal like this. But you can keep your eye out for one if it shows up in the mail or interrupts your dinner. Just be certain not to apply if there’s a chance you’d fail to make the monthly payments on time and then pay off the balance in full before the 0% promotional rate ends.)

Note that in addition to borrowing at zero percent you may also get 20,000 frequent flier miles from your scheme. Buy the bonds via Savings Bonds Direct with a credit card that gives miles, if you have one; use the new 0% offer to transfer $20,000 to that credit card.

(To be safe – if you have any doubt the $20,000 zero-percent credit line will be granted and the balance transfer arrive in time – first transfer the money to the frequent-flier card and only then, when you know it’s been received and you have a nice fat credit balance, go to Savings Bonds Direct to buy your bonds.)

The most you can buy in a single transaction is one $5,000 I-Bond. But you can just do it up to six times in a row. (There is an annual $30,000 limit on any individual’s purchases in any calendar year, although you can buy them for your spouse and kids, too.) Buying $20,000 or $30,000 of bonds takes about 15 minutes, all told.

Note also that with savings bonds, it doesn’t matter what day of the month you buy or sell – you get credited interest for the whole month. In other words, buying right near the end of the month and selling right near the beginning gives you nearly two months’ interest free. (More, in the sense that you get a little grace period from the time you charge them to your card and the time the payment is due.)

Note, finally, that for those who don’t want to bother with actual, physical savings bonds, the Treasury now allows you to set up a paperless Treasury Direct account linked to your bank account. (They always did this with Treasury bonds and bills; it’s new for savings bonds.) But as best I can tell, there’s no way to put your purchases on a credit card, so you don’t get the miles.

Note finally finally that no amount of finagling this way is going to make you rich. But neither will you lose any money with I-Bonds. And in some cases, they may even be cashed in tax-free to help with tuition. So in addition to Tom’s scheme for a quick little profit, you should also consider the possibility of buying them as a long-term investment.

☞ And now (if anyone remembers it) let me do the second part of Tom’s scenario – the $100,000 mortgage taken out at 5.5% pre-tax in order to buy I-Bonds. (‘There ought to be a law against this, and I am sure there is’ Tom wrote.) Well, no, there is not. If you were to borrow the $100,000 specifically to buy tax-free bonds – ‘municipal bonds’ – you might well find the IRS disallowing the interest deduction. But I-Bonds are not tax-free, merely tax-deferred, and you could buy up to $30,000 worth a year for yourself and each of your loved ones without fear of the IRS.

Meanwhile, I-Bonds are free of state and local taxes, which is certainly good in a high-rate state. (Your state taxing authority might conceivably challenge your mortgage interest deduction, but I doubt it.) And even being just tax-deferred has these advantages: you have Uncle Sam’s share of your money working for you until you cash them in . . . and by the time you do begin redeeming the bonds, you might be in a lower tax bracket than you are today.

So it’s not totally crazy. If you ever got tired of paying the mortgage, or if you ever ran into difficulty coming up with the $817 a month to do so – or if inflation fell to zero or (or below) so that the bonds yielded just their base rate of 1.6% instead of their current 4.08% – you could always just redeem them and pay off the mortgage.

And in the event of really serious inflation, your I-Bonds would grow at a nice clip.

Still, it doesn’t grab me. Let’s say inflation averaged 5%, which is quite high, giving the bonds a pre-tax return of about 6.6% (the base rate plus the inflation). Meanwhile, you’re paying 5.5% on the loan. So you’re clearing a mere 1.1% pre-tax, less the closing costs (and hassle) of taking out the loan – and any other problems I haven’t thought of.

Then again, it could be a nice way to force yourself to save. At the end of the 15 years, your mortgage would be paid off! (You wouldn’t really have been paying 5.5% on $100,000 for 15 years; you’d have been paying 5.5% on $100,000 the first month, 5.5% on a remaining principal balance of just $50,000 or so by the 108th month, and 5.5% on a scant $813 principal balance in the last month of the loan.)

What’s more, the tax-deferral aspect increases your return even if your tax bracket is no lower when you redeem the bonds than it is today. To get a sense of this, look at two identical $100,000 investments at 6.6% a year for 15 years and a 33.33% tax bracket. Without the deferral, the 6.6% becomes 4.4% after tax and the $100,000 grows to $190,760. But with the deferral, the $100,000 grows to $260,830, less 33.33% tax on the $160,830 appreciation, for a net of $207,209. That works out not to 4.4% but to 4.97%, which gives you an idea of the extra oomph you get by having temporary use of Uncle Sam’s portion of your money – and extra $16,449 in this example. But remember: this 6.6% I am using assumes a high compounded rate of inflation for those 15 years. And most mortgages do involve closing costs.