Savings Bonds

From Thorsten Kril, recently arrived from Germany: “What is your verdict on EE-Series Saving Bonds? You have only a short paragraph about it in The Only Investment Guide You’ll Ever Need, basically saying they were bad once and not too bad now.

“Here is my situation: In my taxable account I only hold stocks for the long term, adding to the positions every month. Mostly industry leaders, and once in a while some small caps. I avoid Mutual funds and bonds because of the tax mess. Buying funds/bonds every month for dollar-cost averaging and reinvesting the distributions would require a full-time job to figure the taxes once I sell something. Also, I’m comfortable to pick the stocks myself.

“To balance the risk, I have allocated 40% of my 401k and Roth to Bond and Money Market Funds. But I’m 30 and have 30 more years to retirement, so I would rather have a bit more of my 401k and less of my brokerage account in stocks. And since I already maxed out the 401k/Roth contributions, I need another place for my Retirement money. (And you just counseled against annuities.)

“So, the solution that appeared to me is the EE-Series Bond. I can buy them every month and not pay taxes for years. Since every bond matures after 30 years, I could sell the bonds I bought this year when I’m 60, then sell the bonds from next year when I’m 61 and so on. I’d have a steady income beside the volatile stock holdings. It would last until I’m 90.

“So, what do you think? Did I miss anything? It sounds to me like a perfect retirement saving plan.”

Well. You’re obviously doing great – no wonder Germany’s savings rate is so much higher than our own. But you raise a lot of interesting issues, the net of which is: I’d skip the savings bonds.

But let’s start at the beginning:

Savings bonds still make sense for the small saver. For a completely safe investment, the yield is good – set by law at 90% of the yield on 5-year Treasury securities. And the tax advantages make it better still. Like all Treasury securities, they are free of state and local income taxes. On top of that, the EE-Series savings bond interest is free of federal tax, if you choose to defer it, until you cash in the bonds. Certainly this is better than a certificate of deposit at the bank.

But for retirement money you don’t need for 30 years? Even the worst 30 years in stock market history (the beginning of 1929 to the beginning of 1959) would have grown your money much faster, after tax, than savings bonds. And if you think the U.S. market is high today and are looking to diversify, why not buy a little Russia and Thailand this year, something else next year? You have your 401(k), Roth IRA and Social Security to fall back on. Surely you can take the risk that Russia and Thailand (and who knows what else next year) will not all disappear in the decades to come.

Or even just buy some more of today’s robustly priced blue chips. Is there much chance the Hewlett-Packards and Ford Motors and FedExes of the world won’t ultimately be able to grow faster than a savings bond? (I’m not recommending these specifically.)

Says my friend and sage Less Antman: “Nothing makes me sadder than the conservatism of a man of 60 being practiced by a man of 30, so that he’ll need to show the aggressiveness of a man of 30 when he’s a man of 60.”

You should keep ample cash for emergencies . . . to be able to comfortably increase insurance deductibles to the maximum . . . to take advantage of special opportunities to purchase in bulk or at a big discount . . . to send monetary gifts to undeserving and unreliable friends with large upcoming tax bills . . . and to fund for short-term personal goals. But of the rest? “Keep safe money safe,” Less likes to say, “but keep growth money growing.”

(As for the difficulty of dealing with mutual funds: not so. Every large fund family and discount broker keeps average-cost information on mutual fund holdings and provides it on sales. It takes just a few minutes at tax time to copy the sales and cost information to Schedule D from the information sheet mailed by most funds along with the Form 1099.)