0% return?!?! - Update on Series I Savings Bonds

Posted by Paul

(for more detailed info on savings bonds see previous posts on savings bonds: Savings Bonds 8/27/07 and Savings Bonds Revisited 8/22/08)

Those of us who have purchased or who have been following the Series I savings bond got to see some history as the interest rate for a new Series I bond went to 0% for the first time since the I Bond was created over 10 years ago.

What happened? Well the quick summary is that the I bond return is tied to the inflation rate, and for the first time since the bond was created the inflation rate (which is published twice a year in November and May) was negative (specifically -2.78%). If you do the math, this means that the return rate of your bond is negative (even if you bought I bonds when their rate was highest back in 2000 the calculation results in a negative number). Luckily it is made clear that when the rate of the bond goes below 0 it just gets set to 0.

So what does this all mean? Well there is a whole article talking about it here:

Yikes! Series I Savings Bonds paying 0.0%

To summarize some specific points from the article:
"That means your money is still safe from inflation, but you’re getting the same return you’d get by burying it in a coffee can in the back yard."

The article managed to find a small silver lining in all this:
"If you do decide to dump your Series I bonds, you’re in luck. Normally, if you sell a bond less than five years after you bought it, you have to pay a penalty equal to three months interest. Since you’re getting no interest, you’ll owe no penalty."(Hooray?)

For me, I'm just going to hold onto my bonds and see what happens when the rates reset again in six months.

Savings Bonds Revisited

Posted by Paul

If any readers recall my earlier post from 2007 on savings bonds they'll recall that I purchased some and that I wasn't too excited about them at the time.

Well imagine my surprise to discover that currently my savings bonds have an interest rate of over 6%. This is far better than my savings accounts or even my CD's!

I wanted to double check the program that I downloaded that tells me the current rate of my savings bonds, so I went to the page on Series I bonds and confirmed the numbers.

Currently the determined inflation rate is 2.42%, and the bonds that I bought back in 2006 have a fixed rate of 1.4%.

Using the formula we get:

Composite rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)

Composite rate = 0.016 + (2 x 0.0242) + (0.016 x 0.0242)
Composite rate = 0.016 + 0.0484 + 0.0003872
Composite rate = 0.0647
Composite rate = 6.47%

So currently my bonds are earining almost 6.5%. Wow! Pretty good for such a low risk investment!

So what does this all mean? Well I guess it means that if you purchase I-Bonds when the fixed rate is high (the fixed rate doesn't change for the life of the bond), then you can make a great return when the conditions are right.

As an example, let's pretend that I had purchased some I-Bonds back in May of 2000 when the fixed rate was 3.6, their current interest rate would be:

Composite rate = 0.036 + (2 x 0.0242) + (0.036 x 0.0242)
Composite rate = 0.036 + 0.0484 + 0.0008712
Composite rate = 0.0844
Composite rate = 8.4%

That'd be a pretty amazing return for a no risk investment.

I plan on continuing to watch the I-Bond rates and purchase some more bonds once the fixed rate gets up to a decent amount. It's nice to have part of my money in a low risk investment that has a built in guard against inflation.

Savings Bonds.

Posted By Paul
Savings Bonds. You hear about them all the time, usually in the context of an award for spelling bee or a gift from grandma, but are savings bonds in fact a good option for saving and investing?

I did a little research on savings bonds (and even bought some) and this is a summary of what I learned.

First of all, what are savings bonds? They're essentially loaning money to the US Government and have them pay you interest. Along with CD's they are one of the most conservative forms of investing.

There are two major types of savings bonds that I looked into.

Note this info applies to newly purchased savings bonds. The rules for savings bonds have changed over the years so if you have an older saving bonds and you are trying to figure out its value, I would suggest taking it to a bank.

Series EE Bond:
The Series EE bond is a savings bond that you purchase for half of the face value. So if you pay $50 you get a bond that says $100 on it. The interest rate for the bond is fixed at the time of the bonds purchase and never changes for the bond. Also a bond has a maturity term of 20 years. That means that if you hold the bond for 20 years it is guaranteed to double in value.

So you are probably wondering..what if the interest rate on the bond is such that in 20 years the interest hasn't doubled the value of the bond? Well the answer is that the treasury department will make a one-time adjustment to the value of the bond at 20 years making it equal to its face value if the interest over the 20 years hasn't already gotten it there.

After 20 years the bond continues to accrue interest at the fixed rate for another 10 years. After 30 years the bond ceases to earn interest.

Series I Bond:
The Series I Bond is a bond that you purchase at face value (you pay $25 and you get a bond that says $25 on it).

The interest rate on an I Bond is called a composite rate because it's partially fixed and partially variable. The fixed rate is set when you purchase the bond, the variable part of the rate is based on inflation and is recalculated by the US Government every May and November.

The composite rate of an I Bond is determined by an odd formula:

Composite rate = Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)

So the current fixed rate on an I Bond is: 1.3%, and the current inflation rate is: 1.21%. So this means:
Composite rate = [0.0130 + (2 x 0.0121) + (0.0130 x 0.0121)]
Composite rate = [0.0130 + 0.0242 + 0.0001573]
Composite rate = [0.0373573]Composite rate = 0.0374
Composite rate = 3.74%

So notice that if inflation goes up a lot, the interest rate of your bond will go up as well. The idea is that with an I Bond your return will never be outpaced by inflation.

Tax Benefits of Savings Bonds:

Two interesting tax benefits of savings bonds of are that you only pay federal income taxes on the interest you make on the bond (no state taxes). You only pay the taxes when you redeem the bond.

Another interesting point of savings bonds is that:
-------------------
The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE and I Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.
-------------------

The above paragraph (as well as other criteria you have to meet to take advantage of this) can be found at:

http://www.treasurydirect.gov/tdhome.htm

This page also has all of the info on rates and you can even order the form to buy bonds (or you can just go to any bank or credit union and get the form there).

So I bought some I Bonds and they have been...fine. Very safe, not exciting returns. My view on savings bonds after going through the experience is that:

I-Bonds would be interesting if the fixed rate ever goes up to a significant value.

The EE bonds really don't excite me that much.

So if you have some money and want to buy some savings bonds, there certainly isn't much risk involved, but I find it hard to find a compelling reason to invest in them.

Though they do make nice gifts for the grandkids.