Treasury Direct Review: Electronic Savings Bond Security Concerns

Despite the Treasury’s obvious dislike for the small investor, Series I Savings Bonds still offer a relatively good interest rate. As of January 1st, 2012, you will no longer be able to buy paper savings bonds other than a small window using your tax refund. The only option left is buying electronic savings bonds via TreasuryDirect.gov. This brings me to the following reader question:

Was just reading Mel Lindauer’s comments in the Bogleheads forum about I-Bonds and the trouble with Treasury Direct. Seems a great many folks hate the system to the point that they would rather not use it. 2012 is/was to be the year that I first began purchased I-Bonds, having finally got to the point of maxing out all other tax deferred and tax free methods. Now I am not so sure…what is your experience with TD?

First, let’s get to what I see as the main reason why most people choose not to use the online service at TreasuryDirect (TD). TD is not a bank and does not fall under Regulation E and the Electronic Fund Transfer Act that establishes consumer protections for loss or theft of money from your account.

If your paper savings bonds are stolen or lost, the Treasury has a process in place to reclaim your bonds. However, if somehow your electronic savings bonds were stolen, you would stuck with the loss with no liability from TD. It doesn’t seem to make sense, but it’s true.

So what do you do? The easiest thing to do is not use TreasuryDirect. But it remains a good investment, so in my case I looked into what security measures were in place to prevent such theft. In November 2011, TD instituted some security changes to their login process. What would a thief have to do in order to cash in your savings bonds?

  1. They need your account number, which is more like Z-12345678 as opposed to johnsmith.
  2. When you login with a new computer, a one-time passcode will be sent to your e-mail address. So, they would need to have access to your e-mail address as well. You can choose to register your computer for future visits if you like, but it would seem safer not to do so. I don’t log into TD very often so my cookie expires anyway by the time I log in again. This means a unique code is sent every single time I log in.
  3. They would also need your account password. I would hope your e-mail password and your TreasuryDirect password are different. In any case, it’s harder for viruses or keylogger programs to record your password because you must enter it using a virtual keyboard (unless you circumvent it by disabling Javascript).
  4. Now, at this point they have online access to your account and can see your balances. But to cash out a bond, first you must answer a security question (mom’s maiden name, etc.). More importantly, you can only cash out a bond to a linked bank account. So the thief would need access to your bank account (…which is protected by Regulation E mentioned above!)
  5. Alternately, they would need to send in a paper form adding an alternate bank account under their control. However, the name on the bank account must match the name on the TD account, and the form requires a Medallion Signature Guarantee where a third party checks official ID for identity verification. The TD website itself has improved over the years so that any small change (bank addition, profile change) results in a e-mail notice.

Personally, I deemed it exceedingly unlikely for an actual theft to occur and made the decision to go ahead and use the website. My holdings there are significant, but under 5% of total net worth. I know that others have also had technical issues with accessing their account, but I have not experienced anything like that. In the end, TreasuryDirect definitely has its flaws, and I would not fault someone for not using it as a result. You have to weight the risks and benefits for yourself.

TreasuryDirect.gov Security Login Changes 2011

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TreasuryDirect.gov is the official US Treasury website that allows individuals to directly buy securities online, including savings bonds and Treasury bonds. The problem is that they don’t want to take any responsibility for unauthorized access to your account, including reported fraud and theft, which actually makes them less consumer-friendly than even those evil megabanks. In the past, they figured the problem would be best solved with a series of clunky security measures.

I’m not sure why, but they have now streamlined the login process to be more similar to banking industry standards. On November 6th, they sent out the following e-mail to account holders:

TreasuryDirect has completed its security upgrades. Now, it is not necessary to use an access card to log into your account. When you log into your account, you will receive an e-mail containing a one-time passcode and the opportunity to register your computer. Also, for your added security, you will select a personalized image and verify your contact information.

The website was subsequently slammed and completely unusable all day. Always fun to spend the day wondering if your money is still there. :) Today, I was able to log into my account and check out the new process. As mentioned in the e-mail, here are the new layers of security:

  • You must enter your account number, no usernames. So it’s still W-123-456-789, instead of something you would use across multiple websites like “johndoe90210″.
  • If your computer is not recognized, a one-time passcode is sent to the e-mail address on file, valid for only 2 hours. You must enter this passcode to go further, and you can set a cookie to remember your computer and skip this step in the future. For some reason, the cookie didn’t work for me, I always have to go the passcode route. (screenshot)
  • You must set a personalized image and caption text. This is standard procedure amongst banks now to prove that you are on the valid TreasuryDirect site and not a fake spoofing website.
  • Finally, you must enter your account password by clicking keys on a virtual keyboard. This is to counteract keyloggers. As before, You can use a physical keyboard simply by disabling javascript.

I see this as an improvement in accessibility, although probably a slight decrease in security. I’m okay with it; I can finally shred my secret decoder ring access card!

2010 Investment Returns by Asset Class

Vanguard has the year-to-date returns up to 12/31/2010 for all of their mutual funds available right now, so I made a table with all of the funds and asset classes that I like to track for my records. These are almost all passively-managed funds, so they should track their respective indexes closely. 2010 ended up being a relatively good year for most investors, as nearly all the major stock and bond indexes ended up in positive territory. I’ve listed the mutual fund versions for simplicity, even though there is usually an ETF equivalent with similar returns.

Fund Ticker Asset Class 2010 Total Return
Stocks
VFINX S&P 500 14.91%
VTSMX US Total Market 17.09%
VISVX US Small Cap Value 24.82%
VGSIX US Real Estate (REIT) 28.30%
VFWIX International Total Market 11.69%
VGTSX International Total Market 11.12%
VFSVX International Small Cap 17.09%
VEIEX Emerging Markets 18.86%
Bonds
VFISX Short-Term Treasury 2.64%
VIPSX Inflation-Protected Bonds 6.17%
VBMFX Total Bond Market Index 6.42%

As a reminder that being this year’s best performing asset class is no guarantee of for future years, here’s the Callan Periodic Table of Investments that shows the relative performance of 8 major asset classes over the last 20 years. You can find the most recent one below (click to view PDF), which covers 1990 to 2009. (No update to include 2010 yet.) You can find previous versions here.

As you can see, the top performing asset classes is nearly impossible to predict, so holding multiple, low-correlation asset classes and rebalancing can be beneficial.

TreasuryDirect Security: Should All Financial Websites Be Like This?

TreasuryDirect, which allows individuals to buy securities online directly from the US Treasury, has to be the least accessible financial website in the country. It takes me about 20 minutes to log in each time! Let’s look at all the hoops we get to jump through:

Account number – Of course it can’t be a username you can remember like “bob222″, but is more like Z-334-946-124. This makes me have to dig up my encrypted login/password file.

Password – Use your own keyboard? Nope, you must click it out on a randomized virtual keyboard. Gets around basic keyloggers, but not something that catches your screen as well. I’m actually okay with this one, but I’m glad my password isn’t very long and my vision is good.

td_login.gif

Access Card – Finally, you need to read characters off a Access Card in order to access your account. (Like a secret decoder ring!) Of course, being a physical object, I can never find it. I ended up transcribing the entire card contents onto a spreadsheet file, and shredded the card.

Now, finally you can buy a savings bond. Can you imagine the hassle if every financial institution were like this? I understand the need for security, but I think having a physical type of verification token should be an option for the customer, not a requirement.

Lost TreasuryDirect Access Card?
If you lost your card, you’ll have to call (304) 480-7711, verify your identity, and request for a new one to be sent to your mailing address. Your old card will no longer work. In the meantime, no access. Call early and keep trying until you reach someone, because if they’re busy you have to leave a message (no hold system?), and they never called me back.

Treasury Bond Minimum Now $100, But Nothing To Buy

The Treasury recently announced that as of April 7th minimum investment amount for government bonds will be lowered to $100 (previously $1,000). This includes all Treasury marketable bills, notes, bonds and Treasury Inflation-Protected Securities (TIPS). Thanks for the e-mails.

This means you will be able to build a weekly Treasury Bill ladder for as little as $400. Unfortunately, right now yields are so low that I have no reason to bother. The last T-Bill auction resulted in an investment rate of only 0.527% for the 4-week T-Bill, 1.337% for the 6-month T-Bill, and 2.045% for the 2-year T-Note.

Even TIPS are so much in demand that some of them have been trading with a negative real yield. If you are interested in inflation protection, especially for mid-term periods like 5 years, it may be better to simply buy a Series I Savings Bond, which right now has a real yield (fixed rate) of 1.2% through April 30, 2008. You can buy those already for as little as $25 via TreasuryDirect.gov. (There is a purchase limit of $5,000 online and $5,000 paper, although people have reported being able to buy more online.)

My Current Bank Account Setup To Maximize Interest

Over a year and a half ago I shared how I juggled my bank accounts to maximize interest. It was the best I could do then, although it was a bit annoying as transfers between banks still took a couple of days.

banksetup.gif

My current set up now involves fewer banks, but I feel it is also both more convenient and earns higher interest. However, whether or not it would work for others depends on their geographic location.

banksetup.gif

Washington Mutual – WaMu has a strong branch presence in my area, and there are also ATMs in the grocery stores. Since they started offering their Free Checking and 5% Savings account combo (must open online; you won’t find this advertised in any branch), I have started using it as my primary account due to the combination of convenience, decent interest, and lack of fees.

I can keep a minimal amount of money in the no-fee checking account for my daily cashflow needs, and then a larger chunk can be kept in the savings account to cover the larger monthly bills paid via scheduled online BillPay transfers. If I need to write a big check or send a wire transfer, I can just move money over from the savings account. Also, I still receive a lot of checks so I like the ability to deposit them directly into my savings account. Overall, this keeps a good chunk of my money instantly accessible yet earning decent interest.

For reference, see my WaMu Free Checking + 5% Savings review and how to fund them directly with existing WaMu accounts.

28-Day Treasury Bill Ladder – Again, this may not work for others because the main draw of T-Bills is that the interest paid is exempt from state and local income taxes, which increases their equivalent yield. For those without state income taxes, they have been yielding around 5.1%-5.3% APY. However, for those that do have such taxes, the equivalent yield is significantly higher. Mine is closer to 5.8%-5.9% APY. Thus, the money I can’t see myself needing in less than 28 days (most of it) is kept here.

In addition, I can link TreasuryDirect to my WaMu savings account, so there is no interest lost during transfers. The money is invested immediately into a Treasury Bill upon withdrawal, and upon maturity the money is immediately deposited back into my savings account.

For more information, please see my entries on converting Treasury Bill auction results to equivalent bank interest rates, and how to build a T-Bill ladder.

How Do You Account For Interest From Savings Bonds or Treasury Bills and Bonds On Your Tax Return Forms?

If you earned any interest from Treasury Bills or Savings Bonds last year, and are subject to local or state income taxes, be sure note it on your tax returns! Interest from federal debt obligations such as these are subject to federal tax, but not state or local income taxes. Here are some tips and examples to make sure you file correctly and get all the money that’s owed to you.

First of all, you have to manually go and print our your 1099-INT forms from TreasuryDirect.gov, if that’s how you bought or sold the securities. Go to Manage Direct > Manage My Taxes > Year. It’s not elegant, but at least they provide it… (You can also try calling 1-800-943-6864 to request one be sent to you.) On your federal return, there should be nothing specific to note as they are fully taxable at that level.

If you use online tax software for your state/local income taxes, look very carefully for a question that asks if you need to make any adjustments to your federal income numbers, or if you have any interest from government obligations or debt. If you go to an accountant and they don’t know how to do it – fire them ;)

To find out the applicable lines on the paper forms, first locate your appropriate state tax form in PDF format. It might be a good idea to start with the most general all-encompassing form. Then run a search in Adobe Acrobat for “bonds” or “subtractions” or “adjustments”. You are basically looking for the area where you make adjustments to the federal income figure. You may be referred to a supplemental form. Visually skim for keywords like government bonds, savings bonds, treasuries, or treasury bonds.

California Example

  1. I’ll start with Form 540 [pdf], the most general form.
  2. See per the Form 540 instructions that “If there are differences between your Federal and California income or deductions, complete Schedule CA (540) – California Adjustments
  3. Per the Schedule CA instructions: On line 8 enter in column B (Subtractions) any interest from U.S. Treasury bills, notes, and bonds (and also most U.S. Savings Bonds).
  4. Finish the schedule, transfer the appropriate value to line 14 of Form 540, and now your California taxable income should ignore any government debt interest.

Oregon Example

  1. I started with Form 40.
  2. In the “Subtractions” area, I see Line 16 – “Interest from U.S. government, such as Series EE, HH, and I bonds”. This is where I put in the interest from T-Bills as well.

How To Compare Treasury Bill Returns Directly To Savings Account Rates

I’ve been getting a flurry of questions about comparing Treasury Bills to bank accounts. Here is a step-by-step walkthrough to make it from the weekly auction results to a bank’s quoted APY interest rate.

1. From the recent auction results page, grab the investment rate (not discount rate). This is APR. It is based on a 365-day year and reflects the actual annualized rate to maturity. Here’s the most recent snapshot:

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Let’s take the 28-day T-Bill, which has an APR of 5.247%, or 0.05247.

(If you want to learn more about how the other terms and the relationship between “Discount rate” and “Investment rate”, please see this post on T-Bill terms.)

2. Convert it to APY. APY, as opposed to APR, takes into account the effect of compounding interest. It’s also a higher number, which is why most banks just tell you the APY. An approximate way to convert it to APY is using this formula:

APY = (1 + (APR/PeriodsInAYear) )^(PeriodsInAYear) – 1

For our case, the APR is 0.05247 and PeriodsInAYear= 365/28. Solving for APY, you get 0.05376, or 5.376% APY.

This is only a approximation because you can’t actually reinvest all of the money continuously. For example, you might get back $1,000 from your first T-Bill, but can only reinvest $995 of it in the next T-Bill. The rest must sit in a savings account at best. For 28-day T-Bills, you can get a more accurate number using my 28-Day Treasury Bill APY Calculator.

Assuming a 4.89% APR/5% APY savings account, you’d get 5.367% APY, a bit less. If you don’t pay state or local income taxes, you can stop here. As you can see, it’s very competitive with online savings accounts.

3. Find Your Tax-Equivalent Rate. Treasury Bills are exempt from state and local taxes. Thus if you are subject to such atrocities ;), then your T-Bill rate is actually better than that of a fully-taxable bank account. This is one use for my tax-equivalent yield calculator. You’ll need to know your tax rates and whether you itemize taxes.

Let’s use the 5.367% number from Step 2 and my own tax situation. For 2007, I’ll probably be in the 28% bracket federally, 9% for state, and will itemize. For this specific T-Bill, my final number that I should use to compare to banks is 5.898% APY. Your number will probably vary.

Yes, there are a lot of variables to get the conversion just right. Sorry!

If you are interested in investing in Treasury Bills, please also see my visual guide to building a T-Bill ladder to maximize your returns and also liquidity.

How To Build A Treasury Bill Ladder: A Visual Guide

So you’re interested in buying some Treasury Bills for the potentially higher returns, but aren’t exactly sure how to set it up. Well, this guide is for you! I’ve been laddering T-Bills for over a year now in order to maximize the profit out of my existing house downpayment savings and also my no fee 0% balance transfers.

Quick Facts

  1. Treasury Bills are purchased at a discount and redeemed at the full par value. So for each $1,000 worth, you’ll pay ~$99x dollars upon issue and receive $1000 upon maturity.
  2. Rates are set by auction, so you will not know your exact interest rate before you commit to buy. However, if you are in a high income-tax state the chances are very good that it will be better than similar savings accounts.
  3. Auctions are held on Tuesdays, and the T-Bills both issue and mature on Thursdays.
  4. You must schedule the purchase before Noon EST on the auction date (Tuesdays), otherwise you are pushed to next week.
  5. The transfer of money to/from your bank account upon purchase/maturity is very timely. Thus, if one Treasury Bill matures (deposits $1,000) and another is issued on the same day (withdraws $995), your bank account will have a net positive $5 balance at the end of that day.

Visual Guide To Setting Up A Treasury Bill Ladder
Laddering is a method of purchasing that increases the liquidity of fixed term investments such as Treasury Bills. Imagine if you bought a T-Bill every week, and each one lasts for 4 weeks. After four weeks, you could simply use the proceeds of your first T-Bill to purchase your fifth T-Bill. The week after that, you could use the proceeds from your second T-Bill to purchase your 6th T-Bill, and so on forever. If you stopped buying T-Bills, you would get $1,000 back each week until all have matured.

Since each T-Bill has an investment minimum of $1,000, you would need to commit 4 x $1,000 = $4,000. If you don’t have enough, you can simply buy them at less frequent intervals. Below are four visual examples for buying them every month, every two weeks, and every week:

$1,000 Minimum – Buy a T-Bill Every Month
Assuming a discount value of $995:
Week #1: T-Bill #1 will be issued on Thursday (net taken from bank account: -$995)
Week #5: T-Bill #1 will mature (+$1,000) and T-Bill #2 will be issued (-$995) on Thursday (net: -$990)
(and so on…)

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In some months, there may be a gap between the T-Bill maturing and the next one issuing, but you should never have more than $1,000 invested “outside” in T-Bills. However, you may have to wait up to 28 days for your money to come back to you.

$2,000 Minimum – Buy a T-Bill Every Other Week (Bi-Weekly)
[Read more...]

Interest Rate Checkup – Online, Brick and Mortar, and Treasury Bills

Here is brief roundup of the top rates for short-term cash accounts with moderate balances.

Online Savings Accounts, No Minimum Balance
HSBC Direct continues it’s 6.0% APY rate on new money until April 30th, and you can open with $1. The highest non-promo rate is from Amtrust Direct at 5.36% APY, although you must open with $1,000. Overall, rates seem to be stable as of late.

Nationwide Brick and Mortar Accounts, No Minimum Balance
Washington Mutual continues to top this area, with their WaMu 5.0% APY Saving Account. You have to open online, but after that it has all the advantages of a local branch savings account; You can transfer instantly to/from their Free Checking account, deposit directly into savings via ATMs or tellers, and take cash directly out via ATMs.

28-Day Treasury Bills Possibly Good Alternative
If you are subject to state income taxes and have cash reserves that you don’t need immediate access to, you should definitely look into Treasury Bills. Rates change weekly, with the most recent auction results showing a 5.267% investment rate. Using my 28-Day T-Bill APR-to-APY calculator with my new Tax Equivalent Yield Calculator, along with an assumed 25% federal/9% state tax bracket, that is the equivalent of a taxable interest rate of 6.12% APY. Treasury Bills are backed by the full faith of the government, and also come in 3-month and 6-month terms.

The downsides to T-Bills include the fact that you will give up some liquidity and they must be bought in $1,000 increments. For more information on how to buy them online and building a T-Bill ladder, please read the posts in my Treasury Bill category archives. Look for a new visual how-to guide coming soon.

Personally, I continue to purchase T-Bills with a portion of my cash balances as I live in Oregon with a 9% state rate. It is actually very easy to have to money transferred to and from your existing high-yield bank account. For example, if you have $30,000 sitting in a bank, you might commit $20,000 to Treasury Bills and keep the rest 100% liquid. It all depends on what you feel comfortable with.

Also see: Rate Chaser Calculator.

Tax Equivalent Yield Calculator For Savings Bonds, Treasury Bills, and Tax-Exempt Money Market Funds

There are many investments out there that are exempt from certain taxes. For example, U.S. Savings Bonds and Treasury Bonds are exempt from state and local income taxes. In addition, there are money market funds available that are exempt from federal income tax and others that are even exempt from a specific state or city’s income taxes.

Therefore, it is desirable to know what the equivalent fully-taxable rate is for one of these investments. For example, is it more profitable to earn a federal tax-exempt interest rate of 3.8% or a fully taxable 5.0%? How about a Treasury Bill paying 4.8%? Several variables affect this rate, including your marginal tax brackets for each area, as well as if you itemize your state and local taxes on your federal tax return. I could not find a calculator that accurately captured all of this, so I made my own.

Tax Equivalent Yield Calculator
(You may need to be on the individual post page for it to work.)

Enter the interest rate: %
Enter your marginal federal income tax rate: %
Enter your marginal state income tax rate (if any): %
Enter your marginal city/local income tax rate (if any): %
Exempt?
Federal Tax-Exempt
State Tax-Exempt
City/Local Tax-Exempt
Itemize?
Do you itemize deductions? Yes
No
Your tax-equivalent rate:   %

Example
Let’s say you live in California, and your marginal federal tax rate is 25%, your state rate is 9.3%, and you have no local income taxes. You do not itemize your taxes. You are trying to compare the taxable Vanguard Prime Money Market Fund (VMMXX, yielding 5.08%), the federally exempt Vanguard Tax-Exempt Money Market Fund (VMSXX, yielding 3.48%), and the state and federal tax-exempt Vanguard California Tax-Exempt Money Market Fund (VCTXX, yielding 3.38%).

With that profile, the tax equivalent 7-day yields would be 4.804% for VMSXX, and 5.145% for VCTXX, making the California Tax-Exempt Fund the best bet currently for this specific situation.

How It Works (Warning: Math Ahead!)
The calculator computes the tax-equivalent rates by comparing after-tax returns. That is:

AfterTaxReturnEquivalentTaxableRate = AfterTaxReturnTaxAdvantagedRate

Using the California Tax-Exempt Fund example above:

EquivalentRate x (1 – FederalTaxes – StateTaxes) = 3.38%
EquivalentRate x (1 – 0.25 – 0.093) = 0.0338
EquivalentRate = 5.145%

So earning 3.38% free from federal and state taxes is the same as earning 5.145% in a fully taxable account.

Note that itemizing deductions means that you deduct your state income taxes from your federal taxable income. The effect is that your overall tax liability is reduced, which lowers the benefit of any tax-exemptions and thus the equivalent rates. That would change the previous equation to:

EquivalentRate x (1 – FederalTaxes – StateTaxes + (FederalTaxes x StateTaxes)) = 3.38%
EquivalentRate = 4.969%

The inclusion of this option may give different results from some of the other online calculators out there, but I believe it makes the results more complete. Another fully-worked-out example can be found here for savings bonds.

Finally, it may be handy to use this in conjunction with my Ultimate Interest Rate Chaser Calculator. Be sure to compare APRs to APRs and APYs to APYs.

Useful Resources
2007 Federal Tax Rates
State Income Tax Rates
Recent Treasury Bill Auction Results
Savings Bonds Rates

T-Bills Still Good Bank Alternative at 5.29%+ APY

For those subject to state income taxes, Treasury Bills continue to be a good alternative to online banks since their interest is exempt from state and local income taxes. For example, at their current rates my personal tax-equivalent yield is over 5.70% APY. You do lose some liquidity though, so I don’t keep every penny in there. For more information, please check out the following posts in my T-Bill category:

How To Buy A Treasury Bill Online
Taxable Equivalent Rate Calculator
Calculating and Comparing Treasury Bill Returns
28-Day Treasury Bill APY Calculator