U.S. Savings Bonds Have Outperformed Stocks Since 1998?

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A reader recently told me that he was no longer investing in the stock market after seeing the chart below from the Savings Bond Advisor. It shows the total portfolio value after investing equal monthly amounts in either the S&P 500 stock market index or Series I US Savings Bonds. The time period is from September 1998 (when “I Bonds” started being sold) through August 1, 2011. My comments follow.

The past returns of savings bonds are indeed pretty good, but not likely to be repeated. Series I Savings Bonds (I Bonds) were the new thing in 1998, and the government offered some really enticing interest rates on them. I Bonds have a fixed component that lasts for the duration of that specific bond and an variable component that adjusts with inflation every 6 months. From 1998 to May 2001, the fixed component was always between 3% to 3.60% above inflation (source). However, since May 2008, the fixed rate has been between 0% and 0.7%. For the past year, the fixed rate has been a big fat zero. I would love to have a savings bond paying 3% plus inflation (currently 2.30%), as some current bondholders have, but I don’t expect that to ever happen again.

Now, that doesn’t mean that they aren’t still a competitive investment, especially for the short term. Since interest rates are so low, I still buy savings bonds even at a 0% fixed rate as part of my emergency fund cash reserves.

Savings Bonds are being slowly killed by the government. Even though savings bonds have historically encouraged people of all income levels to save, it appears that the US Treasury is slowly killing the savings bond. As recently as 2008, you could buy $30,000 worth of each type of savings bonds a year, per person. For a while, we were able to even use credit cards to buy them without a fee. Today, you can only buy $5,000 of paper I-bonds and $5,000 of electronic I-bonds a year, and even paper savings bonds are being phased out in 2012. (You can still overpay your taxes and buy paper bonds with a tax refund in 2012.) There was even a NY Times article last week entitled Save the Savings Bond. Basically, even if you wanted to create your retirement portfolio with savings bonds, you can’t.

Investing solely in inflation-linked bonds is actually recommended by some financial authors. The thing is, the government has so much debt that it greatly prefers US Treasury bonds which can be sold by the billions. Printing a $50 savings bonds is not even a drop in the bucket, it’s closer to a H2O molecule in the bucket. What you can invest in is Treasury Inflation Protected Securities (TIPS), which like I Bonds are backed by the government and pay an interest rate linked to inflation. Economics professor Kolitkoff in the book Spend ‘Til The End recommends your entire portfolio to be TIPS. The problem? You’re gonna have to save a lot. TIPS yields are very low, currently offering yields of negative 0.7% above inflation (!) for a 5-year bond to a meager 1.1% above inflation for a 30-year bond. If you’re okay with saving 50% of your income every year for 30 years, then this plan might work for you.

There is no easy answer as to the best place to invest right now. I am sticking with a diversified low-cost portfolio with both stocks and bonds (including a nice chunk of TIPS inside, which has done quite well recently), and you can see with this chart that it has also done pretty well the last decade.

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  1. The other problem with TIPS, unlike I-bonds, is they are best to be placed within retirement accounts or your inflation protection is severely muted because of capital gains every you must pay.

  2. And don’t forget the Series EE bonds in the 90’s had a min interest rate of 4%…. for 30 yrs… I bought some over the years but not nearly enough. It was tough to be THAT contrarian back then…. Makes you wonder what the right contrarian move is now.

  3. For the real return on safe investments to get that high again, people would have to be leaving them alone because they’re flocking to more risky investments. Currently, and probably for years to come, people are generally scared of stocks. I hope I’m wrong, but I think we’ll have low real rates on safe investments for quite a while.

  4. I’ve never been a big fan of bonds because of the low returns (I have a very high risk tolerance). Out of curiosity, why do you buy 0% bonds for your emergency funds vs. a money market fund or interest earning savings account?

  5. @Matt Wegner – The real rate is 0%. The nominal rate you receive is the fixed real rate plus inflation of the previous 6 month period. Right now, that’s 4.6% for the first six months you own the bond, much better than a money market fund or interest earning savings account.

  6. Gotcha. I didn’t make the connection that you meant real rate, although now that I re-read it, it’s intuitively obvious 🙂 Thanks for clarifying.

  7. Let’s be clear here, this isn’t just an I bonds phenomenon.

    First, September 1998 is kind of a random date, but since that is what we are using, that’s what I’ll use (since it is the date of I bond inception).

    Using morningstar’s growth of 10k calculator from 9/21/98:

    10k invested in:
    Vanguard 500 Index Fund would be worth $14774 today
    Vanguard Total Sock Market Index Fund would be worth $16613 today
    Vanguard Intermediate Treasury Index Fund would be worth $21598.75 today
    Vanguard Total Market Bond Fu ndwould be worth $20337.98 today

    Of course, I can’t check how it these would have done with regular investments, of say $1k every year. I’m sure there is a way to do that, but it is beyond my skillset.

    The bottom line is that we have been in a secular bear market for equities since 2000 or so. We have been in a secular bond bull market for basically 30 years now (!).
    The inflation adjustment, high previous fixed rate of I bonds has nothing to do with it. It is simply a matter of the continued fall of interest rates on bonds for the past three decades…

    All good things can and will come to an end. Just don’t know when…

  8. @eponymous – great points as always. But don’t forget…
    * Rise/fall of interest rates doesn’t affect value of non-marketable savings bonds
    * Unlike the bond funds mentioned, the savings bonds could be redeemed at any point one year after origination and be guaranteed to have no loss of principal
    * After five years, not even a CD-like redemption penalty
    * Even though purchased in a taxable account, tax deferred until redemption

    Add this to your $10k invested in Sept 1998 list and, given the above factors, it’s clear I-bonds really were a steal:

    I-Bond would be worth $21,156 today

  9. What bothers me is how Savings Bonds are being phased out. It seems to be just another example of how the Government is out of touch with the Common People.

    Of course, I think all Pro Sports Teams should be owned by communities like the Packers are.

  10. The main pitch to buy stocks, versus bonds or cash, is to keep up with inflation. But TIPS will keep up with inflation and let you sleep at night (unless of course Congress decides to default on the debt, but then the whole economy will be in the hell basket)

  11. I’m feeling pretty bad right now about the market. I honestly didn’t expect to end up with a 5 year personal rate of return on vanguard of a measly 3.3%. I guess I wasn’t diversified enough with bonds. Any words of encouragement, Jon? I missed out on a lot of money had I been 100% bonds like a my granddaddy.

  12. In addition to being more reliable than the stock market, I-bonds also have the advantage of being exempt from local or state income tax. Depending on which state you live in, this could be a significant savings.

  13. This was an interesting article which caused me to go back and look. I have stocks, mutual funds, etfs and both types of savings bonds. Everything is entered into quicken so through 6/30/11 from 1998 the annual performance has been:
    Stocks 5.64%
    Saving Bonds 5.34%

    However has been pointed out one can not buy the bonds now I have.

    1998 was one of the glory years, so I went back to 1990:
    Stocks 6.75%
    Bonds 5.34%

    I made a lot of poor choices in stock selection. At one time I had a dozen of microbrewery stocks, but hey one gave a free pint on every visit.

    Good luck!

  14. I was given the advice that people in their 20’s should invest in savings bonds.

    Unfortunately, “Savings Bonds are being slowly killed by the government.” Starting January 1, Americans who want to buy US Savings Bonds will need at least $25 AND an Internet connection.

    If Bonds are harder to come by, what type of investment should someone in their 20’s consider? Is the stock market too risky for an investor that’s just starting out?

  15. Kelsey, there is a school of thought that everybody should have a mix of risky/high expected performance assets (like stocks) and less risky/lower expected performance assets (like savings bonds).

    And that same school of thought generally believes one should have more of the riskier assets when they’re younger (and have more time to recover if the risk shows up) and slowly increase the proportion of less risky assets as you get older. John Bogle (Vanguard founder) has a rule of thumb that your age should be your percentage in bonds.

    I’d suggest you read some of the investing books on this blog’s book review section. My personal favorite is Four Pillars of Investing by William Bernstein.

  16. Dan, thank you for providing your insight. You have a great list of book reviews. I will be delving deeper into your blog this weekend, and will decide on a book or two to purchase. I’ll keep Four Pillars of Investing on the top of my list.

    It’s best to learn finance while I’m in my twenties, so I can be educated about being bold with risky assets like you suggested. I appreciate you taking the time to share your knowledge.

  17. Kelsey, you’re welcome, but just to clarify, this blog and the book reviews are Jonathan’s. I’m just a reader like you. 🙂

  18. hi, can you let me know how i-bonds are taxed?

  19. inq, the default option when you purchase i-bonds is for them to be tax-deferred until either the year you redeem them or else when they mature in 30 years. There is also an option you can specify if you prefer to pay taxes on the interest each year instead if you prefer to go that route.

    Regardless, the interest on i-bonds is state-tax-free, just like all other treasury debt.

    Also, if you qualify under the terms and have specific types of education-related purchases in the same year you redeem the i-bonds you can possibly avoid tax altogether.

    Here’s the page at treasurydirect.gov on ibond taxes:

  20. thanks. if i chose the option to defer taxes to after 5 years do the interest earned every year get auto deposited back (like a compound interest) ? i need to check up on that.

  21. They compound semiannually.

  22. thanks. I was going through Jonathan’s post a few years ago : https://www.mymoneyblog.com/when-should-you-redeem-i-savings-bonds-a-calculator.html. I did not understand how he got the figure 6.91% and what the columns in the excel spreadsheet meant.

  23. On that link, the i-bonds Jonathan bought in 2005 were set to earn 6.91% for six months and then 2.2% for the next six months. He felt he could do better with the approximately 5.25% APY savings accounts or CDs that were available at the time, and was trying to time his redemption of the I-bonds so the three months of interest lost (for redeeming within the first five years) had the least affect on his return.

    These were much funner times in terms of interest rates you could earn on low-risk accounts, lol.

    In any case, the point of the graph was, if you’re going to redeem I-bonds within five years, try to time it so you lose three months of the lower interest rate, assuming you’re at a point where you know the rate of the six-month period you’re currently in as well as the following six-month period.

  24. right, thanks. I got the generic idea but the calculations for oct did not add up to 6.91% and I didnt comprehend the table.. but got the basics though.

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