My wife and I were fortunate enough to recently receive some savings bonds from my wife’s 95-year-old grandfather. The oldest of the savings bonds was bought in July of 1994. He purchased a series EE savings bond for $100, which is now worth about $293 at the time of this writing. To keep things simple, lets round up to $300. Series EE bonds have some special features which make them an attractive investment for conservative investors:
- The bond is guaranteed to double in value over 20 years. Since he purchased the bond for $100, it was guaranteed to be worth $200 in 20 years.
- Back when the bond was issued, it carried a favorable interest rate agreement, which has worked out to a 4% guaranteed rate of return.
- Taxes can be deferred until you cash out the bond. This enhances the bond’s after-tax return compared to most other investments that make you pay income taxes on your interest earnings annually.
This is a great real-life example of the power of compounding! In about 27 years, the $100 grew 200% to $300! According to the bureau of labor statistics calculator, inflation caused cash to lose about 46% of its value over the previous 27 years. The savings bonds were able to protect the value of $100 from inflation and provide a little extra return. This is a fine result, especially considering that this is one of the safest investments on the planet.
However, being a financial planner, I had to look at the opportunity cost. What could that $100 have grown to if it was invested in the stock market (from July 1994 to July 2021)? I’ll define the stock market for this article as the S&P 500. The answer is close to $1,600, assuming dividends were reinvested. This slightly overstates the amount, as taxes on the dividends would’ve needed to have been paid along the way. A rough estimate of factoring in taxes (decreasing the return by 1%) would’ve resulted in about $1,250. Let’s assume that every year the dividends were spent, and the original $100 investment was never touched. The $100 would be worth about $950. Anyway, you slice it, investing in the stock market would’ve produced a materially greater amount.
My grandfather-in-law, a man who lived through the great depression, used the savings bonds to pass along the value of a dollar, and investing conservatively to make sure you never lose money. He also wanted to encourage the idea of giving gifts you will never benefit from. These are wonderful lessons, but I believe he also passed along another lesson. If you’ve got a 20+ year investing timeframe, take a little risk, the reward is usually worth it. You’ll kick yourself down the road if you don’t.
I’m sharing this in the hope that it helps a reader consider what investing lessons they would like to pass onto their children and grandchildren.
Thanks,
Larry
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