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Financial Updates General FI

2022 Q1 FI Progress, Inflation and Breaking My Market Addiction

I’m a big fan of experimenting and trying new things so I’m going to try something new for this latest post. Earlier this year I became more transparent on the blog in posting how we crossed over the 7 figure investment account number and saving over $100,000 last year.

Recently, I wrote about keeping a cool head and on track when the markets start getting volatile (in the downward direction). I’ve noticed a lot of people struggling in this aspect. New investors worried about losing money in the market and stressed by their account balances going down even when they’re actively adding to them!

This post is going to be the start of quarterly updates to our financial situation including the change in account balances. Hopefully it gives some people comfort to know that they’re not alone and the encouragement to stay the course investing in their future.

I’m also going to use this post to talk about some additional small topics. Updates on topics that I’ve previously written about and have taken action on. Things going on in the financial world. Things that are on my financial mind.

2022 Q1 Financial Update:

In my article about the retirement tax triangle, I talked about the benefits of investing in all three of the retirement account types: taxable, tax free and tax deferred. I “eat my own cooking” so to speak, and actually do track my accounts in that way. You’ll see the breakdown of our finances into those account types.

Q1 Total Investment Account (-$37,100) Value Changes:

I like to start at the high level and go deeper into detail so here’s the overall change in value. Current investments is all our invested assets.

Net worth includes our house but assumes that it’s sold. Why? I haven’t written about this yet but right now we’re aspiring to one day to sell everything and tour the US in an RV for potential relocation spots.

Q1 Account Contribution Summary (+$41,985):

  • Taxable (+$16,700)
  • Tax Free (+$4,754)
  • Tax Deferred (+$15,585)

In Q1 our overall investment accounts were -$37,000. Ouch. And that’s AFTER contributing $42,000 into them. In other words a net -$79,000. That’s more than the average US household makes in a year.

That $42k was aided significantly by an annual bonus received in March so that won’t be the norm for Q2-Q4.

That’s how it goes sometimes with being an investor. Losing money, even if on paper, generates pain and emotions. Those can be pretty intense when you’re early in your investing career and not used to them.

I know it’s not what you want to hear, but you have to really experience that pain and control your emotions if you want to grow as an investor. You can’t learn about it in a book or from a story that someone tells you. You need to feel it yourself.

How do you stay the course when it feels like investing is just lighting dollar bills on fire? Look at history to remind you. The S&P500 has gone through periods of tough times but over the long haul, it has always had positive returns over 15+ year periods.

S&P500 historical chart from Macrotrends

Q1 Net Worth (-$17,800) Value Changes:

News flash – the housing market is still bananas. We own a very modest 1,500 square foot “starter home” in a moderate cost of living location. Our housing prices here in western NY state generally don’t boom or crash but they’re resumed their insanity since the start of 2022.

Our home value went up almost $18k and we paid down $3,200 of our mortgage. I had been overpaying more on the mortgage in Q1 but now that the market has had some more substantial drops will back off that. I’ll invest more in our taxable investment account instead. I ran the numbers on pre-paying my mortgage vs. invest in this article.

The Zillow Zestimate change over the last 3 months has been an $18,000 increase or over 10%! Crazy. Rising mortgage interest rates is really pushing people to try and get into a house is what I’m guessing.

At some point the increased mortgage rates will make buying at elevated prices unaffordable and I think prices will come back down to earth a bit. A 30 year mortgage at 6% has a monthly payment that’s about 40% higher than a mortgage at 3%.

Taxable Accounts Value Change (+$4,150):

Here are our contributions to these accounts this quarter.

Q1 Taxable Account Contributions: +$16,700

  • Brokerage – Added $5,500 to the account.
  • iBonds – Bought $11,500 between funds that had been sitting in cash and from new income.
  • Crypto – removed $5,300 from Stable coins to put back into HYSA’s for our travel fund and part of our emergency fund. Added $5,000 to BTC and ETH.

iBonds had been on my mind even before writing this detailed all about iBonds article. Mrs. MFI had some emergency fund cash sitting in a 0.01% savings account so we put that to work. We had more than enough EF cash if I were to lose my job so we were comfortable putting it into iBonds.

I decided to dial back the risk a little and take some of our sinking funds out of stable coins. I have a 75% written article on stable coins to discuss the level of risk there. They seem low risk in theory but just because you can’t see the risk, doesn’t mean that it isn’t there.

We contributed $16,700 and saw the overall taxable account values go up $4,150. Ouch.

Tax Free Accounts Value Change (+$4,754):

Q1 Tax Free Account Contributions: +$9,700

  • Cash – Removed $10k to buy iBonds. Added $5k back into the “cash” category from stable coins as a part of our travel fund and emergency fund.
  • Roth IRA – Added $12k. Executed back door contributions to max out both Roth accounts.
  • HSA – Added ~$1825 in contributions. Also moved $2k that was stuck in Mrs. MFIs HSA bank account. We’re both setup to max our HSA contribution for a combined total of $7,300 for the year.

In total we added about $9k to this category but it’s only up $4,700. Because our HSA’s are our retirement healthcare fund, we don’t need them for 25 years so they’re invested 100% in stock indices (VTI and VXUS). The

Tax Deferred Accounts Value Change (-$46,000):

One caveat to the tax deferred contributions. We are saving after tax dollars into the Mr. MFI 401k to perform a mega backdoor Roth contribution in 2022. That account will get more than $20,500 contributed to it but the after tax portion will get rolled out in November 2022.

Q1 Tax Deferred Account Contributions (+$15,585):

  • Mr. MFI 401k – $6,750 in my contributions. $3,710 in company contributions.
  • Mrs. MFI 401k – $5,125 in her contributions.

These accounts are a little heavier on bonds at a roughly 70% stock / 30% bond split. Both got hit hard and dropped in value.

Financial Topics On My Mind:

Breaking My Addiction To Watching Markets Daily:

In a recent article I talked about methods for avoiding investing mistakes. One key method was to stop watching the markets every day. I personally struggled with this one a lot.

I got into the habit when I was trading futures and Forex. Futures trade 24 hours a day from Sunday at 6pm EST to Friday at 6pm EST in my markets.

Determined to fix this, I’ve successfully stopped my daily watching and have now fallen back to looking at the market on the weekend when they’re closed.

Yes, I still have the urge to check during the week if I catch a piece of financial news. Yes, I’ve had a couple of slip ups. But, it’s a vast improvement from the 4-5 times a day that I was routinely looking at the market.

Roth 401k vs. Traditional 401k:

Mrs. MFI and I are both currently maxing out our 401k accounts with traditional 401k contributions. We both have the option to contribute some percentage as a 401k if we choose.

In my tax triangle article I noted that I was considering flipping over some or all of our contributions over to Roth since we were heavy in our traditional 401k accounts.

Account percentages in February 2022

Right now any contribution that I changed from traditional to Roth 401k would be taxed at 24% given our highest marginal tax bracket. We’re piling money into a Roth due to the mega backdoor but with $50k+ being contributed to our tax deferred accounts annually it won’t make up any ground.

My thinking at the time was that in 2026 the tax brackets will reset higher so better to take the tax hit now with a Roth 401k and in 2026 I could flip those back to t401k. I don’t like to do these types of changes without more analysis though so I’m staying the course for now.

I’ll do the analysis in a future article but I think we’ll have plenty of low income years between age 55 and 67/70 to draw down those tax deferred accounts while keeping our effective tax rate low.

Inflation, Interest Rates and Bonds:

Inflation. Everywhere you read in 2022 everyone is talking about inflation. They just released the April 2022 CPI report and it showed 8.5% annual inflation increase.

The stock market is going down so people don’t want to put money there. Interest rates are rising so intermediate term and long term bonds are getting crushed. People have discovered iBonds once again so they’re becoming very popular with a May 2022 annualized rate of 9.62% but they have low purchasing limits at $10k/person/year.

This period is indeed painful, but it will get better. The beauty of bond funds is that they constantly have bonds hitting maturity with new bonds being purchased at the new, higher interest rate. Over time, the yield to maturity will get higher and higher until interest rates level off and eventually drop.

If you need bonds for stability because of your risk tolerance and timeline, then hold bonds. Don’t let short term interest rates influence your asset allocation. Don’t let the interest rate risk tail wag the dog.

Taxable Account – Stay with Vanguard, Move to Fidelity, Move to M1 Finance with ETF’s

In my most recent article about mutual funds and ETFs, I contemplated the idea of moving to ETF’s to avoid the risk of taxes after the Vanguard target date fund incident of 2021. That kills my ability to automate my investments though with Vanguard since they’re pretty behind the times technology wise.

Since I only invest in passive index based mutual funds I think the risk is low of some special tax bomb event. Vanguard does let you flip from mutual funds to equivalent ETFs without selling your holdings.

So, the plan for me is to stay with mutual funds for now so I can keep auto-investing. When we get closer to switching from accumulation to drawing down I’ll likely migrate that account to ETFs and then move it to Fidelity for simplicity. We’ll likely collect all our funds there for ease of management.

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Investing

iBonds: Good Inflation Protection Or Overrated?

BLUF: iBonds do provide a safe bond that provides inflation protected income. However, with their buying limitations and short term illiquidity you do need to understand their limitations.

It’s always interesting to me when something in the world changes and all of sudden you start hearing about something “new” for the first time. In 2021 and 2022 that something in the world changing was the jump in US inflation rates for the first time in decades.

US Inflation rate by year
Source: https://tradingeconomics.com/united-states/inflation-cpi

The hot “new” investing option that emerged in the news in November of 2021 was this thing called an iBond. They’ve been around since 1998 but since inflation has been fairly low they weren’t all that attractive of an investment option. You can see this peaking of interest in the google search trends.

Google Trends for the term “iBonds”: Source: https://trends.google.com/trends/explore?date=today%205-y&geo=US&q=iBonds

Bonds decrease in value when interest rates go up and raising interest rates is a normal response to inflation. As such, people became worried about their bonds dropping in value with the threat of inflation.

What are these bonds that has everyone so interested? How do they work? When might iBonds make sense for you? I’m going to tackle all of these questions and more along the way.

What is an iBond?

This is a bond invented by Apple. Okay, not really. But if Apple did invent a bond it probably would have been called that.

This is a bond issued by the US government that not only pays a fixed rated of interest, but it also pays an inflation adjusted interest rate. There are many unique things about this bond though that make it quite different than individual bonds or bond funds that you might be used to buying.

We’ll dive into the details of each area of iBonds but here is the high level summary of them.

How Much In iBonds Can I Buy?

iBonds are unusual in that there’s a limit to how much of them you can buy. They’re sold as electronic bonds with a $10,000 per social security number (SSN), per year limit. That means that you’re fairly limited on buying them.

You can buy them on behalf of your spouse or children to increase the amount you can buy. For example, if you were married with 2 kids then you could buy $40,000 / year. An adult needs to open the kids account and then link the kids account to the adult.

Electronic iBonds are sold in any denomination down to the penny from $25 up to $10,000. You could be a $73.96 iBond if you really wanted to. Paper iBonds are only sold in denominations of $50, $100, $200, $500 and $1,000.

How Is iBond Interest Earned?

Things get a little tricky when it comes to calculating the actual interest that you earn on your iBonds. Lets step through the details slowly.

There are two interest rates that make up an iBond.

Fixed Rate: The fixed rate is an annualized rate of interest on your iBond. It’s set when the iBond is issued and never changes over the life of the bond (up to 30 years if you don’t sell it).

Inflation Rate: The inflation rate is the 6 month (semiannual) rate of interest earned on that bond. This is updated every 6 months and usually changes.

Your bond returns are a combination of the annual fixed rate + semiannual inflation rate.

All of these rates can be found here at the TreasuryDirect site.

That interest rate chart is a little confusing without some explanation. Refer to the picture below where I’ve marked up part of the TreasuryDirect interest rate chart to explain what’s going on.

Source: https://www.treasurydirect.gov/indiv/research/indepth/ibonds/IBondRateChart.pdf
  1. Issue Date: Your iBond will fall into one of these 6 month windows depending on the purchase date. These windows run November 1st to April 30th and May 1st to October 31st.
  2. Fixed Rate: The fixed rate is an annualized rate of interest on your iBond. This is set for the life of the iBond.
  3. Semiannual Inflation rate: The inflation rate is a 6 month (semiannual) rate of interest on your iBond. It is updated every May and November using the CPI-U (Consumer Price Index-Urban) metric.
  4. Nov-2020 Column: Annualized rate of return for an iBond based on that 6 month inflation period beginning November 1st, 2020. The inflation rate is the same for the period but then it’s combined with the fixed rate of each row to get the cell cotents.

For the blue box, the 2.18% is the annualized rate for an iBond issued between 5/2019 and 10/2020. Annualized inflation rate (0.84% * 2) + fixed rate (0.50%) = 2.18%.

This is confusing, though, because that inflation rate changes every 6 months. Lets show how this interest is calculated in a real world example.

iBond Interest Calculation Example

Say you bought a $10,000 iBond on March 1st, 2020 which has a fixed rate of 0.2% annualized. You can see the interest rates for that iBond row highlighted in red below.

Over the next 6 months you would get a combined 1.11% interest rate (0.1% fixed + 1.01% inflation). That would pay you $111 in interest which then gets added to the principle starting on 9/1/2020. That’s because the compounding period for an iBond is 6 months.

Inflation dropped to 0.53% for the 6 month block starting on 9/1/2020 so the interest rate for that 6 month block dropped to 0.63%. Using a new principle amount of $10,111, that provides $63.70 in interest over that 6 month block.

This continues on until the iBond matures at 30 years or you sell it. There are no tax consequences while you hold the bond as none of that interest is being distributed to you.

Negative Interest Rates

What happens if inflation goes negative (deflation)? The composite interest rate (fixed + inflation) can never below zero where you’d be giving back interest each month to the government.

However, it is possible the inflation rate to go negative and nullify interest from the iBond’s fixed rate. For example, say you bought an iBond in January of 2019 with a 0.50% fixed rate. If the inflation rate when negative in November of 2022 at a rate of -0.6% then the bond would pay 0% interest for that 6 month period.

This happened in May 2009 when semiannual inflation went to -2.78%. It wiped out the fixed rate returns for even iBonds with the highest fixed rates.

How are iBonds Taxed?

iBonds are subject to ordinary income taxes at the federal level but not to state or local taxes.

It’s important to note that no taxes are due until the iBond is sold or reaches maturity. There are no income taxes to report on an annual basis unless you sold the iBond that year.

How Do I Buy iBonds?

TreasuryDirect.gov login

You can only buy iBonds in two ways.

  • Electronic iBonds – TreasuryDirect.gov sells them online. You are limited to $10k / SSN as previously mentioned.
  • Paper iBonds – If you have a federal tax refund coming to you, you can file IRS form 8888 with your return and direct up to $5,000 in $50 increments to be bought in iBonds.

How Do I Sell iBonds?

Here’s another unique aspect of iBonds, their liquidity (or lack thereof). iBonds aren’t held in a brokerage or retirement account. There is no open market to buy or sell them with other market participants. It’s just you buying and selling them with the US Treasury department.

Just like buying the bonds, you do the selling of them through the treasury direct website.

Can’t Sell iBonds Within A Year

Unless you’re affected by a natural disaster you cannot sell your iBonds within the first year. Here is an iBond that I bought last month. See any sell button? Nope!

Interest Penalty If Sold Within 5 Years

If you sell an iBond within the first 5 years of holding it then you forfeit the previous 3 months worth of interest that you accrued.

How Useful Are These In Your Portfolio?

Time to get to the meat the of what you care about. Are these right for my portfolio?

As we’ve previously covered, iBonds aren’t bought or sold like your other investments. You can’t buy them with a 401k, IRA or brokerage account. You need to create a special account. You can’t buy as many of them as you want due to the $10k/SSN/year limitation. Honestly, they’re kind of a hassle.

If you have a $1M 80/20 portfolio and you wanted to move your bonds to iBonds because of inflation concerns you would need to move $200,000 to iBonds. If you were married it would take you 10 years to make that happen! Not very practical.

You could of course do it slowly over many years where you invest $10-$20k/yr layered in over many years. If we were to have a similar situation as we did in the 1970’s where inflation was up for a decade then this could work out in your favor. You can always liquidate the bonds at any time after that first year. You may have some increased taxes to pay on the gains but that’s a better problem to have than a loss of purchasing power.

Source: https://www.macrotrends.net/countries/USA/united-states/inflation-rate-cpi

Should iBonds Be In Your Emergency Fund?

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Photo by Pixabay on Pexels.com

What’s the purpose of your emergency fund? It’s to provide cash to save your butt in the event of an emergency. iBonds are illiquid for the first year so you better not buy them using any money that you need to access for with a year. Store that money in a high yield savings account or you could consider a combination of options.

Therefore they aren’t appropriate for most 3-6 month emergency funds. If you had a 2-3 year cash bucket in retirement it would be more reasonable to buy iBonds. But it’s only going to work for a small percentage of that cash bucket to start and could take many years to get the full amount invested.

You’d have to work through your plan and see you wanted to use a combination of HYSA and iBonds to balance returns with liquidity. Just remember though, the purpose of holding cash is usually liquidity, safety and optionality. Not returns.

Holding iBonds In Your “Cash” Retirement Bucket?

The most logical time to consider iBonds would be if you’re going to be holding a fair amount of cash but don’t need to deploy that cash quickly.

If you had a 2-3 year cash bucket in retirement it would be more reasonable to buy iBonds for a portion of that money. But it’s only going to work for a small percentage of that cash bucket to start and could take many years to buy those iBonds depending on that bucket size.

You’d have to work through your plan and see you wanted to use a combination of HYSA and iBonds to balance returns with liquidity. Just remember though, the purpose of holding cash is usually liquidity, safety and optionality. Not returns.

Are iBonds Good Inflation Protection?

iBonds are actually excellent inflation protection for the cash that you are able to invest in them due to their purchasing limits. Inflation rising can often mean the risk of interest rates increasing which hurts bond returns.

iBonds have the unique characteristic of being a stable US backed bond, yet they don’t go down in value if interest rates go up (interest rate risk). Their fixed interest rates are low so the bulk of the return component is that inflation adjusted rate. In a rising interest rate environment of current 2022 (to battle inflation) iBonds get a stronger return from that increasing inflation.

As inflation decreases so do your iBond returns. However, they can never go negative on their interest rate so there’s a backstop on the downside.

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