Buying I-Bonds in November: Worst Case Scenario

So what’s the worst case scenario with I-Bonds if you cash out in a year? Well, that would mean deflation. Contrary to what some believe, the fixed rate is not the minimum you get. The minimum return is zero (see #5 of FAQ), meaning at least you don’t lose anything.

So 6 months at 6.73%, and then 6 months at 0.0% (3-month penalty of… well, nothing). Buying late in November, you’d actually be holding it for 11 months, working out to an annual rate of about 3.67%, not including tax benefits. Of course, deflation is very unlikely. But that’s still the worse case scenario (barring Armageddon).

Comments

  1. Correct. In essence it was like the money never left your savings accont… ;) For those of us who bought some in October we’re in even better shape. In the event of 0% rates we can hold for 15 months (14 actually) and have no interest penalty (just the loss of use of the funds for a couple of months)

    I don’t think we’re in any real danger of seing deflation any time soon though…If Armageddon does happen to kick off in the next 12 months (actually 6 months if it is going to impact CPI) I’ll be too busy stocking my underground lair to worry about savings.

  2. Dr. Goldman says:

    Don’t forget the latest inflation rate is among historical highs. We all saw gas price dropped from $3+ to now $2.1 or so. Deflation is not unlikely in the short-term. If there’s inflation, it’ll be close to 0%-1% at best.

  3. The fixed portion minimum I mentioned yesterday was a rumour from some other corner of the Internet I have to admit. Thanks for researching this matter Jon. But that #5 confuses me a little.
    “…the redemption value of your I Bonds will remain the same until…” The “same” as its original value, meaning it can’t get cheaper than its purchase price or the “same” as its last month’s value, meaning it can’t earn negative return?

  4. Except for tax advantage reasons, short term (1 year) I-Bond’s are not worth it at the present time. You can get a 4.65% 1-year CD, if you want to lock your money for 12 months. The only way this can change is if you wait until the end of April AND inflation continues to be high. Then, at the end of April, you can make a wise decision as to whether or not to get into I-Bond’s for a 12 month period. You will, at this point, know exactly how much inflation has occurred over the previous six month period and you will be able to predict fairly accuratly how the I-Bond rate will change for May 1st. You will be able to pick up the 6.73% rate for six months, as long as you buy before May 1st and, assuming inflation continues to remain high, you will be able to take a similar rate for six months thereafter.

    The question of what do I do for now, while I wait for April can best be answered one of two ways:

    1) Put your money into a good money market account, which will pay you close to 4% while you wait.
    2) Put your money into a 6-month CD, which will pay you 4.35% while you wait, but will not be accessible until beginning of May, requiring you to potentially take a very short term loan (several days), to offset this period, as you “transfer” from CDs to the I-Bond in late april.

    Mike G.

  5. Well, by Armaggedon I meant that the U.S. Government gets taken over by super-intelligent were-bunnies, and can longer pay back interest OR principal.

    Got any extra space in your underground lair? =)

  6. Mike G, I think you’re deluding yourself:
    “You will be able to pick up the 6.73% rate for six months, as long as you buy before May 1st…”

    If you jump in just before May 1st, i.e. end of April, you’ll “pick up the 6.73% rate” for only one month, namely April, not six. Why would FRS pay you interest for November-March period on I-Bonds you did not own then? To earn this 6.73% for whole six month period you need to buy now (end of November). In April this train will be long gone.

  7. Vlad – I’m afraid you are incorrect. I-Bonds pay the rate in place when you buy them for 6 months, and then change to a new rate for another six months.

    For example, the rate that ALL I-bonds pay did not change this November. My bonds that I bought in October will pay 4.8% for 6 months, and then 6.92% for 6 months starting in April.

    As for the latter part of what Mike said, I would just say that taxes matter, so I am personally also looking at T-Bills. Some people also have strong feelings about the direction of inflation.

  8. Actually, by assuming 0% interest for months 7-12 (or 11, however you want to count), you are assuming deflation since you have some positive fixed rate (let’s use your 1.2%). So… am I missing something here, or did you analysis not take into account the fixed rate that you are sure to get (by no inflation, I thought you meant 0% for the variable term)?

  9. Nevermind… I read your article too quickly. I see what you are saying now.

  10. Yep, worse case scenario is deflation of greater than 1%, negating the fixed rate.

  11. With (still) rising interest rate (before Greenspan’s retirement) and dropping gas price, the economy will likely cool down starting next year. I can’t imagine a greater inflation number unless we face another big disaster.

    Approximately,
    Fixed rate 1.0% + (2*inflation rate)

    If inflation is flat (0-1%), we can expect 1.0-3.0% interest next year. If deflation rate is more than 0.5%, interest will drop down to 0%.

  12. I’d be careful predicting deflation anytime soon. Although oil prices have dropped somewhat, they still remain high and many businesses have yet to pass on the full extent of higher energy prices. I’m not sure about semi-annually, but there has not been a negative CPI figure since 1955 (http://minneapolisfed.org/Rese.....st1913.cfm). I don’t think the Fed would raise rates if they expected or began to see signs of deflation.

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