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Hi Scott.

For my retirement funds, do you think it is better to invest in an I bond fund, or to build a ladder of individual I bonds?  My broker charges $25 for each non-competetive auction purchase of Inflation Indexed bonds, no matter how many are purchased at once.  I would only be purchasing one $10,000 bond at a time.  I currently only have 3% of my retirement assets in I bonds, with a goal of 10%, and I will be retiring in 5 years.

Bryan 

Bryan,

 I think there is some confusion here. I bonds, or I Savings Bonds, are issued directly by the Treasury to individuals and, sadly, the maximum purchase has recently been reduced to $5,000 for Treasury direct purchases and $5,000 for paper bond purchases per Social Security number.

TIPS, Treasury-Inflation-Protected-Securities, are probably what you are buying. These are best purchased inside a tax-deferred account because the inflation adjustment for these bonds is taxable income but you do not receive it in cash.

At a purchase cost of 0.25 percent ($25/$10,000) it's pretty much a push on whether you build a ladder of individual securities or buy a fund. As a practical matter, however, building a ladder is the better option IF you have definite plans for when you want to access the money. With a schedule of maturities, you'll be able to avoid interest rate risk. You can do that owning shares of a mutual fund that invests in TIPS.

Scott

Scott, I just finished Spend Til The End (another great book by the Burns/Kotlifoff Duo!). In it, you suggest allocating substantial percentages to TIPS, particularly for those with high aversion to risks. I have a significant nest egg (and am retired as is my wife) and plan to delay social security until age 70 for both of us (ESPlanner has confirmed the prudence of doing so.).

 As a corollary question to Bryan's original post, since it would take so long to build a substantial position in TIPS individual bonds (due to the annual limit per person of $30K), is using Vanguard TIPS funds a wise alternative? Is there a risk of loss of principle unlike buying individual TIPs bonds? What are the downside risks to going the fund route versus the individual bonds?

Light Heart,

Let's start with some nomenclature first. It is I Savings Bonds that have the annual investment amount limit. It was $30,000 but it has recently been lowered to $5,000 making them far less useful as a retirement planning tool. This is sad because they are simple and your investment return is tax-deferred until the bonds are redeemed, making planning and use very convenient.

That leaves us with TIPS, Treasury Inflation Protected Securities, that are regularly auctioned by the Treasury. You can buy any amount of these securities but they have a tax disadvantage--- you are taxed on the inflation adjustment portion of the return AS WELL AS the premium over inflation paid on the bonds. This is called "phantom income"--- you owe taxes on cash you never received.

For that reason, virtually all investors buy TIPS in qualified (tax-deferred) accounts rather than taxable accounts. Except for those with very large portfolios, most people should buy these bonds via a mutual fund or ETF such as Vanguard Inflation Protected Securities, or I Shares Lehman TIPS.

Scott