Savings I-Bonds November 2009 Fixed Rate: 0.3%

The new fixed rate for Series I Savings Bonds (“I Bonds”) was announced on Monday to be 0.3%. This is a follow-up to the ~3.07% inflation rate previously calculated based on CPI-U data.

As a long-term investment, a 0.3% real yield makes I-Bonds a slightly worse choice than Inflation-Protected Treasury Bonds (TIPS). As of yesterday, a 5-year TIPS had a 0.73% real yield.

As a short-term investment, it depends on how you think inflation will turn out in the near future. If you buy a new I-Bond in November, you will earn 0.3% fixed + 3.06% based on inflation = 3.36% for the first 6 months. The second 6-month rate will be 0.3% + a variable rate based on inflation from September 2009 to March 2010.

(Savings Bond Reminders: You must hold for at least a year (or 11 months and a day if you buy on the last day of the month). If you hold for less than 5 years, there is a penalty of the last 3-months interest. Savings bond interest is exempt from state income taxes, and all taxes can be deferred until the time of bond redemption.)

Worst case scenario, there is deflation of worse than 0.3% which makes the total rate zero for the 2nd six months. Earning 3.36% for 6 months with an 11-month holding period gives you an effective rate of approximately 1.83% APY. This is only slightly lower than the top yields for a 12-month CD. If the annualized inflation rate over the 2nd 6 months is just 1%, your effective rate after the 3-month interest penalty rises to 2.00%. It’s not a screaming buy, but if you are looking for 1+ year safe investment and haven’t exceed your annual purchase limits, I would personally buy them over a bank CD since you do well in cases of rising inflation and okay otherwise.

For more background, see the rest of my posts on savings bonds.

Comments

  1. You completely ignore the tax differences when comparing I-bonds, TIPs and CDs, which is a mistake in my opinion.

  2. MoneyProgress says:

    Thanks for the post! Always look forward to your i-bonds analysis.

    I would also be interested in learning more about how TIPS might make a better long term investment. I always get confused when I read about TIPS.

  3. @Steve – I don’t know about completely, I’m just not psychic and don’t know your tax situation. Did you read the Savings Bonds Reminder section? As noted, TIPS and I-Bonds are exempt from state income tax, and I-Bonds have the feature of deferred interest.

    If you live in a state with no income tax, or plan on redeeming soon, the differences don’t matter. Otherwise, there may be an additional advantage to I-Bonds.

  4. Always, always look forward to your I-Bonds post. Bought some back when the fixed rate was 1.2%. Sad that the last 6 months I’ve been earning a fat 0 but it should be better now.

  5. While I agree they are similar, I guess I just don’t see I-bonds and TIPs as being as interchangeable as you seem to. That is ok.

    As for not knowing my tax situation, I agree, and therefore don’t know how you can make a definitive statement like “As a long-term investment, a 0.3% real yield makes I-Bonds a slightly worse choice than Inflation-Protected Treasury Bonds (TIPS). As of yesterday, a 5-year TIPS had a 0.73% real yield.”

    Is holding a TIPS in a taxable account (for whatever reason that is necessary) still better then the I-bond?

  6. Steve
    I bonds need a more closer look interms of their tax advantages, I try to include the state local income tax into their annual yield,
    even if the second 6mnth yield is zerothe one year annual yield would be (1.83% + state income tax on the interest earned), with the added advantage they the penaly for withdrawing them before 5year being zero.

    If the inflation picks up then I’m guessing the worst case scenario the yield would be 0.30%+ potential state income tax on the interest earned (assuming inflation is zero and not negative). (Also in this scenario TIPS when held in a tax deffered account might be a better alternative since you will be earning more than 0%)

    The last time when I bonds total yield was 6.73%( in 2004-05?) the cd rates were about 4%APY (due to the low fed rate compared to then inflation rate). This situation may very well happen again if there is stagflation (there is a big possibility the growth will be small and prices of commodities might go up)

    Or if the bank CD rates shoot up (if the fed rates increases dramatically) more than the yield of the then I bonds, we need to see if tax advantage of I bonds will make the real yield more than the CDs (when held in a taxable account) (I bonds here in this scenario act more or less like munis).

    Bottomline the type of account where you want to park your savings cash (either taxable or tax deffered) makes a significant difference. As with anything else there is an element of uncertainity in choosing these savings vehicles.
    The government is pretty hypocritical when it comes giving common people access to a straightforward savings choice. On one hand they want us to save, on the other hand they keep the fixed rate (of Ibonds) extremely low and the process of coming up with the fixed rate secretive (we are supposed to be in a democracy right?) it’s one way to plunder common people.
    I’m just a layman, please correct me if I’m wrong with my opinion…

  7. Thank you for the update. I do try to steer folks away from the I-Bonds as “Investments”, instead recommending them occasionally for their son or daughter entering into college a year from now. Having no downside risk, there is somewhat of a chance to catch an increase in the bi-annual rate adjustment based on inflation.

  8. Below is copied from your above Post.

    Worst case scenario, there is deflation of worse than 0.3% which makes the total rate zero for the 2nd six months. Earning 3.36% for 6 months with an 11-month holding period gives you an effective rate of approximately 1.83% APY. This is only slightly lower than the top yields for a 12-month CD. If the annualized inflation rate over the 2nd 6 months is just 1%, your effective rate after the 3-month interest penalty rises to 2.00%. It’s not a screaming buy, but if you are looking for 1+ year safe investment and haven’t exceed your annual purchase limits, I would personally buy them over a bank CD since you do well in cases of rising inflation and okay otherwise.

    If i earn 3.36% for the first 6 months, and another 3.36 % for the second 6 months, why isn’t my apy 3.36%, plus a wee bit more because of the compouning after the firs 6 months.?

  9. @jay ell – It is due to the fact that if you sell your I-Bond after a year (which is the worst case scenario), then you have an early cash-out penalty in which you lose the last 6 months of interest. You can avoid this penalty if you keep it for at least 5 years.

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