Savings I-Bonds Update: September 2010 Inflation Data Announced

New inflation numbers are out for September 2010, so it’s time for another semi-annual update:

New Inflation Rate
March 2010 CPI-U was 217.631. September 2010 CPI-U was 218.439, for a semi-annual increase of 0.37%. (This was 1.1 increase over the last 12 months.) Using this official formula, the variable interest rate for the next 6 months will be approximately 0.74%, depending on the fixed rate. Here’s the math:

218.439/217.631 = 1.00371, or a semi-annual increase of 0.37%. Using a fixed rate of the existing 0.2% announced in May 2010:

Variable rate = 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)
Variable rate = 2 x 0.00371 + (0.00371 X 0.002)
Variable rate = 0.00743, or 0.74%

Buying Now? If you buy before the end of October, the fixed rate portion of I-Bonds will be 0.20%. You will be guaranteed a total interest rate of 0.20 + 1.54 = 1.74% for the next 6 months due to previous deflation, and 0.20 + 0.74 = 0.94% for the six months after that. The inflation component will continue to change every six months. You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur a 3-month interest penalty.

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. Let’s say we buy on October 31st. You’ll be able to sell on October 1st, 2010 for an actual holding period of 11 months. You have to be careful with transaction cut-off times, though, otherwise you may trip into the next month. (3-month interest penalty still applies.)

Buying Later? If you wait until November 1st, you will get a new unknown fixed rate + ~0.74% for the first 6 months, and an unknown rate based on ongoing inflation after that. Based on the tiny fixed real rates on the related Treasury Inflation-Protected Securities (TIPS) currently, my guess is that the new fixed rate is likely to remain very low, perhaps even zero.

Despite these yields not being especially attractive right now, I am thinking about buying some more I-Bonds for my emergency fund, and will probably split them between buying late in October and in November since to me there is not a clear choice to go with one over the other.

Existing I-Bonds? If you have an existing I-Bond, the rates reset every 6 months depending on your purchase month to your original fixed rate + variable rate. I have some at 1.2% fixed rate, which will give me 1.94% for the next 6 months. Interest on savings bonds is not subject to state income taxes. Also, one of the benefits of I Bonds over TIPS is that the total rate (fixed + inflation) can ever go below zero, providing some protection from potential deflation.

Beware Low Purchase Limits
The annual purchase limit is now $5,000 in paper I-bonds and $5,000 in online I-bonds per Social Security Number. For a couple, that’s a $20,000 total cap per year. If you have children, you may be able to buy additional savings bonds by using a minor’s Social Security Number (additional considerations apply).

Buy online at TreasuryDirect.gov. As for paper, here is a post on how to buy paper savings bonds from your local bank. According to this Pittsburgh Post-Gazette article, the Treasury has indicated that it plans to phase out paper bonds in the near future.

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

Comments

  1. Not attractive at all with the low fixed rate…

  2. My question is: why wouldn’t I just wait until we are in a increasing rate environment before I would purchase I-bonds, I do not see how I would miss out on anything by not purchasing at such a low fixed rate. It just seems to me that there is a time to buy I-bonds and a time not too and the fact inflation is so low or non-existing then I would be better off keeping cash in a higher yielding savings acct etc.

  3. Why wouldn’t you just put the money in a savings account earning 1+% instead of this where you only earn 0.97%? A savings account you can take out the money any time too…

  4. @sdf. ibonds unlike other savings will grow tax free until they are redeemed. In addition, ibonds can be used tax free for college education for your children.

    Some of the things I mention in a recent blog post of mine.

    http://investorjunkie.com/2877/i-savings-bonds/

  5. For I Bonds purchased before November, shouldn’t the yield for the next 6 months be 1.74% instead of 0.97%?

    From the Treasury Direct:

    The 1.74% earnings rate for I bonds bought from May 2010 through October 2010 also will apply for the succeeding six months after the issue date

    That helps makes things a little better, but not by much…

  6. According to my calculations, you need over .8% on the fixed rate just to keep the after-tax value with inflation.

  7. The OP’s formula is incorrect( or incomplete). The formula is
    FR + (2 x IR) + (Fr x IR).

  8. I look at iBonds as part of a diversified portfolio. I’ve been buying ibonds for about 14 years so essentially, they are cash that is inflation protected. (8% of my portfolio) People forget that it wasn’t long ago that the ibonds were yielding between 4-6%. When I retire , I will have my ibonds to get me through the downtimes. (flucuations of the market)

  9. I bond benefits over a savings acount:
    1. Exempt from taxation by any State or political subdivision of a State (except for estate or inheritance taxes).
    2. Federal taxes can be deferred until the bonds are redeemed.
    3. Interest earnings may be excluded from Federal income tax when used to finance education.
    4. Some inflation protection.

    Bill, with the current low limits on savings bonds purchases ($5000/year) it is difficult to fully take advantage of “increasing rate environment” when it comes around. For me, it makes sense to buy now, but to use the rates of return on individual bonds to determine which bonds to cash in first.

  10. @Ken – You are correct, I listed the semi-annual rate instead of the full annual variable rate. I knew I’d miss something when editing this at an internet cafe. So buying in October you’d get 1.74% for 6 mo and then 0.94% for 6 mo.

    @a – Depends on your tax rate and also potential tax deferral. But yes, it will be hard to overcome inflation after taxes. However, you could apply the same math to other investments like a bank CD or online savings account.

    @KGS – When I write variable rate, that refers to the inflation rate that varies. (As opposed to the fixed rate.) So we are in agreement.

    Variable rate = 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)

    @Hmm – Yes, the special advantages of I bonds and the low purchase limits are what keep it an attractive investment for me.

  11. Matthew C. Waterman says:

    I really appreciate this data. I buy at least $25 worth every month, sometimes more when rates are higher. What I plan to do is redeem older bonds every time the base rate is raised, since you can hold these up to 30 years. Once I get a nice high base rate then I should get a beautiful return if I just hold onto it.

    For this reason I’m really hoping for some of that hyperinflation that everyone’s screaming about.

  12. But expected inflation for the next 10 years is about 2%…

  13. Matthew C. Waterman says:

    I wouldn’t bet on it with the amount of money supply that’s been created. That said, the majority of my investments are in higher yielding stocks and other types of bonds, especially foreign. If rates do stay low then I’ll just keep putting in the $25 a month. If they go up I will probably be motivated to increase that.

  14. Jonathan,

    First of all thanks for publishing all this useful information about Series I bonds.

    I have been thinking of buying some – perhaps end of July – I wanted to know if you think its a good investment for the next 1 year time frame compared to CDs/online savings accounts? And if July would be a good time to buy?

    Thanks.

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