Savings Bond Alert #016

Tuesday, November 1st, 2005
Categorized as: Savings Bond Alerts

Treasury drops I bond fixed rate to 1.0%

The U.S. Treasury slapped small investors with lower Series EE and I Bond rates today, even though interest rates in the open market have risen during the last six months.

The Series I Bond fixed base-rate was set at 1.0%, down from the previous 1.2%. The EE bond rate was set at 3.20%, down from the previous 3.50%.

Large investors who buy TIPS, the Treasury’s marketable security comparable to I Bonds, have seen the 5-year yield rise in the last six months to 1.81% from 1.28%, an increase of 53 basis points. By dropping the I bond fixed base rate 20 basis points, the Treasury is forcing small investors to take a rate 0.73% less, in comparison to large investors, than what it offered six months ago.

Large investors who buy 10-year Treasury Notes, which the Treasury “uses” to set the EE bond rate, have seen their yields rise in the last six months to 4.57% from 4.21%, an increase of 36 basis points. By dropping the EE bond rate 30 basis points, the Treasury is forcing small investors to take a rate 0.66% less, in comparison to large investors, than what it offered six months ago.

Because of the jump in inflation during the last six months, the initial interest rate for Series I Savings Bonds purchased during the next six months will be 6.73%, up from the previous 4.80% rate.

The new Series I rate is made up of the 1.0% fixed base rate and a 5.70% inflation component. The inflation component applies to all Series I Savings Bonds and is up from the previous level of 3.58%.

Older Series I bonds will earn from 6.73% to 9.39%, depending on issue date, during their next six-month rate period.

Older Series EE Savings Bonds issued between May 1997 and April 2005 will earn 3.61% during their next six-month rate period, up from the previous 3.42%. Rules for these bonds force the Treasury to set the rate at 90% of the 5-year Treasury Bill rate, which has also risen during the last six months. Series EE bonds issued prior to May 1997 pay a variety of rates.

Also this month, the final issue of Series E bond that paid interest for 40 years reached final maturity and stopped paying interest. All Series E bonds issued before December 1975 are now stinker bonds and should be redeemed.

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FDIC Insured Certificates of Deposit can pay 1 or 2% more than savings bonds when held for a similar length of time. See top CD Rates Below:


On November 1st, 2005 Anonymous said:

So, it seems attractive to get an I-Bond with a 6.73% APY, but I think this is a fallacy! Consider the following scenario:

You have $25,000 to invest and you buy an I-Bond today.

You get 6.73% APY for the first 6 months. At this point the treasury department readjusts the fixed and inflation based components to say 4.80% – the previous value, which is as good a guess as any. So, what do we have for a 15 month commitment – the minimum necessary:

6.73% for 6 months
4.80% for 6 months
0.00% for 3 months (the early withdrawal penalty)

Compare this with a good 1 year CD, which currently pays 4.6%, combined with a 3 month CD after 1 year, which currently pays 4.25%. Of course, chances are that the 3 month CD will pay more 1 year from now, but let’s base everything on today.

4.6% for 12 months
4.25% for 3 months

So, what do we get:

$26,440.15 is our future value with the I-Bond
$26,423.52 is our future value with a 1-year CD followed by a 3-month CD

As you can see, these I-Bonds are not as great a deal as they were made to appear to be, for short term investments.

On November 1st, 2005 Mario said:


What do you think about the following possibilities …

(a) The reason for the unexpectedly low rates is that the government is trying to get everyone to buy marketable Treasuries which they have recently integrated into the same system.

(b) Rather than following the TIPS real yield, they are somehow trying to adjust for the timing differences between TIPS and I bonds (i.e. total yield on TIPS for the future not known but guaranteed for I bonds for 6 months)… even though in the long run this timing issue makes little difference as far as real yield is concerned (but may make a difference for short term investors).

Would you mind commenting on the disadvantage of jumping into TIPS, for instance, instead of continuing I bonds as a small investor?

On November 1st, 2005 Anonymous said:

Hi, I am the same person that posted the message starting with “So, it seems attractive…”

Here is what I think is the correct course of action for maximum flexibility, short term:

If you are buying today ($10k or more to invest), buy a 6-month CD (4.35% APY from In just under 6-months, take a look at how inflation has been behaving. If inflation returns back to its normal low levels, implying that the I-Bond’s APY rate will drop back into the 4’s, stick to CDs. If inflation remains at its anomalous high level, put money into the I-Bond as late in this 6 month cycle as possible. The reason why should be obvious, by now:

You will get 6.73% for the 6 months after you invest in the I-Bond (just before May 1st, e.g. April 25th). Also, you will get somewhere in the same neighborhood percentage wise for the next 6 months. Assuming that CDs do not take a giant leap forward, which you will be able to judge at this point, since you are taking a wait and see approach, the I-Bond will make more sense.

The only problem with this strategy is the crossover period between when your 6-month CD can be cashed in (May 1st) and when the I-Bond purchase must take place (maybe as late as April 27th or even 28th). You may need a 2-3 day bridge loan, the cost of which, especially if you already have a line of credit on your house, does not factor much into the equation.


On November 1st, 2005 Mario said:


Not a bad strategy. Another alternative might be to keep it in a high yield savings (EmigrantDirect etc. 4.0%) for now, which may actually go up within 6 months with rising rates (or down, but you can pull the money anytime if it does). The you also don’t have the small timing problem with the 6 month CD. I think the way inflation will be headed will become quite apparent within the next couple of months and EmigrantDirect guarentees the rate until the end of the year.

For people that want to go the “TreasuryDirect” way another new possibility might be to get 91-day or 182-day Treasury bills and wait until maturity (to avoid paying a fee to sell) and see how inflation develops. The current yield on 91-day bills is approx. 4.0% and on 183-day4 it is 4.3%. Granted no advantage there over a CD, except for the marketable character.

On November 1st, 2005 Anonymous said:

I would look at this scenario to the comment of “So, it seems attractive to get an I-Bond with a 6.73% APY, but I think this is a fallacy! Consider the following scenario:” Instead of 15 months. Hold the Ibond for 12 months. it would be 6.73% for 6 months and then x(assume 4.8 as well) for 3 month. and 0% for 3 months. the rate for one year would be 4.57%. However if you buy at the end of November 05 and sell at the beginning of november 06. then the rate will be closer to 4.95

On November 1st, 2005 Tom Adams said:

Regarding the questions concerning Series I Savings Bonds as short term investments:

There are two two-week periods a year when you can compare Series I Savings Bonds to short term investments. These are at the end of April and October.

During this two weeks you know the rates of the I Bond currently available and you know the inflation rate that will be applied six months later.

Two weeks ago, for example, we knew that an I Bond purchased before the end of October would have a one-year APY of 4.13% after the early withdrawal penalty.

Although the average one-year CD paid less than that, there may have been some banks offering higher rates.

At any rate, it doesn’t make any sense to try to predict what a one-year rate on I bonds would be now that the October I bond is no longer available. The next time you can do this with certainty will be in April.

Savings Bonds are designed to be long-term investments, so it’s always kind of a freakish surprise when they pay higher short-term rates than other investments.

On November 1st, 2005 I Bond Rookie said:

Don’t the various calculations all focus on short term returns? Doesn’t this sacrifice one of the attractive elements of I-bonds – tax deferred income?
If one were able to invest large sums of money in I-bonds, these fractional differences might matter. Since the annual investment is limited to $60,000, isn’t simpler (more liquid) better if the investment is going to be short term anyway?

On November 1st, 2005 Anonymous said:

Does it make sense to keep EE bonds that were bought in 2004 that pays 3.61% and still adjusts every 6 months when I can get an emigrant account paying 4%, or a 1yr cd and get about 4.6%?

On November 1st, 2005 Anonymous said:

I am a bit outraged by the low fixed yield declared by the treasury today. Will they give us a premium on the fixed rate when there’s deflation or anemic inflation! Not only is the real inflation under-reported IMHO, we also got screwed on the fixed!

Would’nt the 5yr TIP or the Vanguard inflation fund be a better choice, I wonder!

On November 1st, 2005 Tom Adams said:

On the question of switching to TIPS:

If you have a TreasuryDirect account, it’s easy enough to invest directly in TIPS. Here are the major differences:

1.) TIPS are available only in $1,000 increments. So you have to invest a minimum of $1,000, and if you want to invest more, you have to jump to $2,000, and so on.

2.) Each month, the Treasury adjusts the value of your TIPS investment – up or down – by the inflation rate for that month. In times of deflation, there is no limit to how much the value can decrease. With Savings Bonds, deflation can wipe out the fixed base-rate, but the value of a Savings Bond never goes down.

3.) With TIPS, you earn interest (at the equivalent of the fixed-base rate) on the inflation-adjusted value of your investment. The interest is paid to you in cash rather than compounded as with Savings Bonds.

4.) TIPS don’t have the tax-deferral feature of Savings Bonds. You owe tax on the TIPS inflation adjustment that is added or subtracted from your principal – but you don’t receive any cash to pay it with.

5.) TIPS come in 5-year, 10-year, and 20-year maturities. If you don’t sell in the open market, you’ll get your original investment and inflation adjustments back at the end of the term you select. Even if deflation occurs, you are guaranteed to get back your original investment.

6.) You can only buy TIPS from the Treasury a few days a year. 5-year TIPS are available at the end of April and October. 10-year TIPS are available mid-month in January, April, July, and October. 20-year TIPS are available at the end of January and July.

7.) The value of a TIPS investment in the open market goes down when interest rates go up and vice-versa. The ratio is about 4% of value per 1% of interest rate change for TIPS 5 years from maturity, 8% of value per 1% change for TIPS 10 years from maturity, and 12% of value per 1% change for TIPS 20 years from maturity. The value of a Savings Bond investment does not change with interest rate changes.

8.) In addition to purchasing TIPS from the Treasury, you can buy them directly from a broker or you can invest in a TIPS mutual fund.

The primary advantages of Series I Savings Bonds compared to TIPS are the tax-deferral feature, the ability to get your money back whenever you like after one year, and the fact that the value of the I bond can’t go down.

The primary advantage of TIPS is that they pay a base rate that’s currently about .75% higher than I bonds.

On November 1st, 2005 Mario said:


Based on what we learned today, do you have a new approach in mind on how the Treasury sets the fixed rate?

It appears to be contradictory that they have showed somewhat of a short-term mindset today (trimming the fixed rate based on a high inflation component) when these bonds are designed as long term investments. Any chance they will show a short-term mindset next time around when inflation is low, that they’ll raise the fixed rate? (Has not happenend in the past.)

Eventually I’d like to build a portfolio of high fixed rate I bonds and in the long term I don’t even mind if this means investing in times of low composite rates. Otherwise I might stay away in the future from this investment which I have had high regards for so far. I hope the folks at the Treasury can hear me!

On November 1st, 2005 Tom Adams said:

Mario – the Treasury’s goal is to finance the public debt at as low a rate as possible.

However, the I bond rates they are paying – looking back over all the I bonds sold since their introduction in September 1998 – is relatively high compared to their other sources of funds.

I suspect the Treasury thinks Savings Bond investors will still find the 6.73% I bond rate attractive.

Also keep in mind that Savings Bonds cover only about 2% of the country’s debt, so if they miss by a few basis points it’s not a big deal from their frame of reference.

On November 1st, 2005 Banking Guy said:

FYI, the history of I Bond rates is available here.

Back in May 2002, the inflation component was only 0.56%. They chose to keep the fixed rate constant at 2% even though it resulted in the very low combined rate of around 2.58%. The Treasury didn’t see the need to increase the fixed rate to make it comparable to similar investments. But when inflation is in our favor, they lower the fixed rate.

It’s very disappointing. Looks like it’s going to be a long time before we see fixed rates like they were back in 2000….


On November 1st, 2005 Tom Adams said:

Ken –

Agreed. The Treasury has shown it’s willing to give big investors higher rates and small investors lower rates.

On the other hand, we hear this same music in relation to taxes and health care, so I guess I was a bit naive to think they’d play a different tune for investors.

On November 1st, 2005 Mario said:


Well, I for one think you have done an excellent analysis for the rate prediction. In an ideal world, certainly the fixed rate should have gone up (and for that matter also the EE rate). Unfortunately we’re dealing with a less than ideal response to a market situation in an effort of the government to further its unknown agenda in this matter. Nonetheless, thank you for the analysis, I’m sure we’ll learn a lot on future May 1st’s and November 1st’s about the Treasury…

On November 2nd, 2005 Anonymous said:

I truly enjoy getting this bond info. I buy I Bonds and look forward to the pearls of wisdom you pass along as well as investors who write in.

On November 5th, 2005 Anonymous said:

Does it make sense to keep EE bonds that were bought in 2003 that pays 3.61% and still adjusts every 6 months when you can get an emigrant savings account with no minimum paying 4%, or a 1yr cd and get about 4.8%?

On November 5th, 2005 Tom Adams said:

There’s no easy answer to this question.

With the Savings Bonds, you know you’ll always get 90% of the 5-year Treasury security rate.

With the bank products you’ll get whatever the bank feels like giving you. The rates you are quoting are money-losing rates for the bank; they have them that high to attract name recognition and new customers. For example, says the average rate on 1-year CDs today is 3.8% – 1 percentage point lower than the CD rate you’re quoting.

It’s unlikely that these banks will always offer rates so high relative to the general level of interest rates.

There are also tax differences (federal income tax deferred with Savings Bonds and no state or local income tax) between the products and the three-month interest penalty for early withdrawal on the Savings Bonds to consider.

Moreover, it sounds like you’re interested in short-term accounts. Savings Bonds really need to be held five years to be as good as they can be.

Comments Closed

June 1, 2010

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