Since inflation-linked savings bonds (“I bonds”) are based on CPI numbers announced two weeks earlier, we can make predictions about upcoming savings bond rates before their official announcement. This also allows us the opportunity to know exactly what a current bond purchase will yield over the next 12 months, instead of just 6 months.
New Inflation Rate
September 2013 CPI-U was 234.149. March 2014 CPI-U was 236.293, for a semi-annual increase of 0.91566%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be approximately 1.83%. The new fixed rate won’t be announced until May 1st (speculation below). You add the fixed and variable rates to get the total interest rate. If you have an older savings bond, your fixed rate may be different.
Purchase and Redemption Timing Reminder
You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur an interest penalty of the last 3 months of interest. A known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. It’s best to give yourself a few business days of buffer time though, since if you wait too long your effective purchase date may be bumped into the next month.
Buying in April
If you buy before the end of April, the fixed rate portion of I-Bonds will be 0.2%. You will be guaranteed the current variable interest rate of 1.18% for the next 6 months, for a total rate of 0.2 + 1.18 = 1.38%. For the 6 months after that, the total rate will be 0.2 + 1.83 = 2.03%. Let’s say we hold for the minimum of one year and pay the 3-month interest penalty. If you buy on April 30th, 2014 and sell on April 1, 2015, you’ll earn a ~1.31% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. That is better than any 1-year bank CD that I can find right now, keeping in mind the liquidity concerns and the purchase limits. If you hold for longer, you’ll be getting the full 1.705% over the first year.
Given the combination of current low rates and the fact that you lose the last 3 months of interest (again, for holding less than 5 years), it might be better to wait long enough to grab 12 full months of interest by holding for 15 months (14 buying late). If you buy on April 30th and hold until July 1st, 2014, you’d achieve a annualized return of ~1.46% over 14 months.
Buying in May
If you wait until May, you’ll give up the opportunity to lock in the 0.2% fixed rate from April. Instead, you will get 1.83% plus an unknown fixed rate for the first 6 months. The next 6 months will be the sum of the same unknown fixed rate plus an unknown rate based on future inflation. If there is high inflation for the next 6-month period, buying in May may get you a higher rate sooner. My best guess for the fixed rate is that it will be somewhere between 0.0% and 0.4%.
Inflation appears to be picking up, so I’m not sure if it is best to lock in the guaranteed above-market rates for 12 months by buying in April instead of May. You could always wait all the way until in October for the next rate announcement, but if you have the cash now you’ll have the opportunity cost of lower rates until then. Besides, if rates spike, you’ll eventually get the benefit of any higher rates eventually in the future anyway.
If you have an existing I-Bond, the rates reset every 6 months depending on your purchase month. Your bond rate = your specific fixed rate + variable rate. Even at a low or even zero fixed rate, your existing savings bonds are paying more than current savings accounts and will continue to be hedged against inflation, so weigh carefully whether or not to redeem them.
Annual Purchase Limits
The annual purchase limit is now $10,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. Buy online at TreasuryDirect.gov, after making sure you’re okay with their security protocols and user-friendliness. If you have children, you may be able to buy additional savings bonds by using a minor’s Social Security Number.
For more background, see the rest of my posts on savings bonds. I’m keeping all of mine for the foreseeable future, due to their tax deferral possibilities and other unique advantages. Compare the rates on these savings bonds to what you’re earning on your FDIC-insured bank deposits or even your TIPS and bond mutual funds, and you may find them a good addition to your portfolio.