New Year's Resolution Number Two

Yesterday, it was revealed that the number one New Year's resolution here at this blog is to have more fun in the new year. We'll see how that goes. Somehow it already feels like there will be more complaints than chuckles, which naturally leads into today's topic - New Year's resolution number two:

Stop Using Inflation Protection from the Government

This realization and a new plan of action came into sharp focus while doing a bit of year-end accounting on some personal finances. More specifically, after letting a few months go by without checking in on some I-Bonds that were purchased a couple years ago, it was quite a surprise to learn first hand that the U.S. Government had been protecting bond holders from inflation for a good part of last year by paying them two percent on their debt - inflation protected securities they call them.

What a deal!

For the government.

After doing the math, it became clear that the already small sum entrusted to the U.S. government to protect from the ravages of inflation should be reduced to zero immediately and protection sought elsewhere.

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It's kind of like mob protection when you think about it. They're the ones reducing the value of the dollar with each passing day - and they offer protection?

The funds will likely be converted to old style money (gold and silver) that provide no guaranteed returns but seem to function better as a store of value. They've provided pretty good inflation protection in recent years and it appears that, as we enter 2007, they're just getting warmed up.

Naturally, Our Story Begins with Real Estate

A couple years ago when we sold an overpriced California home and joined the ranks of renters (only to watch California real estate become even more overpriced), most of the proceeds from the sale were invested in hard assets - energy, metals, related equities, and foreign currencies mostly.

So far, so good.

A bit further down the list was a small allocation for I-Bonds that promised a secure principal and a guaranteed rate of return indexed for inflation. From the Treasury Department website, the formula is relatively simple:

Composite rate = Fixed rate + (2 x Semiannual inflation rate)

There is actually another term added to the sum above - the fixed rate times the semiannual inflation rate - which turns out to be an amount so small compared to the other two terms that you wonder why they even bothered to include it (other than the obvious reason that someone might think that they're getting a higher interest rate when they're really not).

So in the simplest case, for a fixed rate of 2 percent and a six month inflation rate of 2 percent (an annualized rate of 4 percent), you'd get a composite rate of 2 + 2 x 2 = 6 percent.

Not bad.

Annual inflation is probably closer to eight percent than four percent these days (ask any senior, check your 2007 health care premiums, or see what cafeteria prices have risen to), but six percent is still better than you'd do at most banks these days, and for a portion of 2006, I-Bonds actually paid close to seven percent.

A Surprise in May

Well, apparently consumer prices rose only 0.5 percent for the six months that spanned the end of 2005 and the beginning of 2006, resulting in the May figure shown circled below that would eventually work its way into the rate of return on I-Bonds held here.
For the last few years, up until the 2006, the Fixed Rate for the calculation had been only one percent which, when combined with the 0.5 percent above, yields the following:

Composite rate = 0.01 + (2 x 0.005) = 0.02 = 2 percent

Oh yeah, there's the 0.01 x 0.005 that gets tacked onto the end, so add in another 0.00005 for a grand total of 2.005 percent.

There can be up to about a eight month delay for rates to take effect for an individual account and, as the ones held here are only half-way through the six month cycle, set to earn a whopping 4.1 percent when the 1.55% rate takes effect in a few months, it is time for a quick parting of ways with Treasury Direct.

In what has turned into a real farce that more and more people are realizing - that the government is lying to them about inflation - you can now be protected from inflation at a rate that is below what can be earned in a simple money market account.

Inflation protection from the U.S. government was outperformed by real inflation protection - gold - by about 20 percent last year. Go figure.

A few years back, when short-term rates were at the pedal-to-the-metal lows of one percent and you'd see money market and CD rates at ridiculously low rates of like 0.09 percent, inflation protection rates of two or four percent wouldn't have gotten too much scrutiny, but today this sort of inflation protection just seems silly.

Wasn't it better when inflation really was low (not just reported as being low by government statistics) and you could earn six percent at a bank? You didn't need protection from inflation and you could really come out ahead just by saving.

Buy gold, buy silver.

You'd get better protection from the mob than you would from the government.