Savings Bond Alert #031
Wednesday, October 17th, 2007
Categorized as: Savings Bond Alerts
Next I bond inflation component will be 3.06%
The next I bond inflation component will be 3.06%, up from the current 2.42%. The component is based on the difference between the Consumer Price Index in March (205.352) and September (208.490). The September CPI was released this morning.
To determine what your own I bonds will earn during their next six-month rate period, you have to add their fixed base-rate to the 3.06% inflation rate. The fixed-base rate for your I bonds can be anywhere between 1.0% and 3.6%, depending on when the I bond was issued.
Moreover, keep in mind that the new interest rate for your I bonds will not necessarily begin on November 1. Instead, new rate periods begin every six months starting with the month in which your I bond was issued. So, for example, an I bond issued in July begins new rate periods in July and January.
Because the Treasury doesn’t have public criteria for setting the fixed base-rate for new I bonds, it’s impossible to predict what the next I bond fixed-base rate will be. If the Treasury keeps the current fixed base-rate of 1.3%, new I bonds would have a composite rate of 4.38%.
The Treasury appears to set the fixed base-rate for new I bonds about 1 percentage point lower than the rate on 10-year Treasury Inflation Protected Securities (TIPS). Yesterday, that rate was 2.31%, indicating that if the rate was set today we’d see a unchanged base rate of 1.3%.
However, TIPS rates, like Treasury rates in general, have been volatile since mid-summer because of the evolving financial crisis related to investments in mortgages. You can follow the daily 10-year TIPS rate on the Treasury’s web site.
The average rate on a new 6-month bank CD this week was 4.53%, according to Bankrate.com, indicating that new 6-month CDs continue to outperform new Savings Bonds. And don’t think investors haven’t noticed. Treasury reports indicate that new investments in Savings Bonds for the 2007 Fiscal Year (Oct-Sep) will be about $3.5 billion - down more than 55% from FY-2006.
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Tom Adams
Timely, informative, well written. Tom Adams is the best!
Thanks, Tom.
As usually the question comes up: what’s the easiest way to make a decision re. NEW investment: am I better off buying a CD or i-Bonds? I assume that if I buy I-bonds between now and Nov 1, I would get 4.38% w. an i-Bond (1.3% fixed) - is this correct? After Nov 1, the fixed rate could go down or stay the same. One can easily get a 5% yield on a 6M CD. Based on this, how do I figure out which one is a better investment, taking taxes into consideration? I am looking at i-bonds as a long term investment (hold them until maturity or retirement or until exchanging them to another issue is more profitable) and I am assuming a 28% tax rate.
Looking at the statistics regarding investments in savings bonds, is the Teasury trying to discurrage people from investing in them?
Tom,- SHOULD I WAIT TILL NOVEMBER TO BUY I BONDS OR BUY THEM NOW IN OCTOBER ?- WHAT DO YOU THINK THE FIXED RATE WILL BE ? KEEP UP THE GOOD WORK, YOU HAVE HELPED ME A LOT THANKS, RICK
Richard and Susan - The markets are too volatile to predict what the Nov 1 I bond fixed rate will be.
They’re volatile because of a lack of trust, which is the essential requirement for capitalism to work (lot’s of people think it’s greed, but capitalism works just fine without greed; without trust, it collapses). The big players in the markets are having a crisis of trust because some assets (bundles of home mortgages) that have been put up as collateral for short-term loans (called asset-backed commercial paper) aren’t worth the paper they’re printed on. It’s not really a liquidity crisis, it’s an insolvency crisis.
As new groups come to understand what’s going on, there are repeated flights to safety, which means huge sums of money flood into the market for US Treasury securities, knocking the rates down and the prices up. Then foreign governments that hold tons of Treasury securities take profits on the increased prices and the money goes back out again. As the money leaves the Treasury market, prices fall and rates rise until another group comes to understand the nature of the current crisis, and more money floods back into Treasuries.
Anyhow, probably more than you wanted to know, but that’s why there’s no way to predict what the next base rate will be. Things in the financial markets are a mess right now.
Susan - in terms of your question about the impact of taxes - if you held the bonds for 20 years and they averaged 5%, you’d get the equivalent of an extra 0.5% on the interest rate from tax deferment.
However, if we get more inflation over the 20 years, and the I bonds average 7%, then the bump you’ll get from tax deferment will be closer to 2.0% (and after 30 years, 3.0%).
Tom Adams
Tom, don’t you think it is not really suitable to compare rates between iBonds and 6-month CDs? Since the minimum holding period for iBonds is one year and if you redeem at the 1-year anniversary you lose 3 months’ interest, shouldn’t the right comparison be between the 4.67% average 1-year CD rate (bankrate.com) against an effective 3.29% for iBonds (4.38%x.75=3.285%) if one redeems the iBonds after holding them for one year? Thanks.
Hi Freda - Yes, that’s a valid comparison if you think you’re only going to invest for one year. But if that’s your plan, you probably shouldn’t be in Savings Bonds anyhow.
I brought up the 6-month CD idea for people who are investing in Savings Bonds every month. My suggestion is that an investor will earn more in 6-month CDs for the next six months than either E or I Savings Bonds. At the end of 6 months, the investor can re-evaluate the situation.
The problem with this suggestion, of course, is that CDs aren’t as safe as Savings Bonds. When a bank goes bust, the FDIC sees that you get your investment back, but it takes months before you get the money and you lose all the interest.
Savings Bonds should be thought of as a very conservative investment - the place to put the portion of your savings that you can’t afford to lose - and the place where you’re happy to earn just a bit more than the inflation rate.
Tom Adams
Thanks for your explanation. Now I get your point regarding 6-month CD rates. In this age, Treasury’s idea of a 3-month penalty for 5 years truly seems to be so archaic…
Freda, I think the 3-month penalty is reasonable. Compare it to a 5-year CD, early withdrawal penalties are often around 6 months of interest. After 5 years it has the awesome advantage over most other investments that you can cash it in anytime penalty-free, or receive a guaranteed fixed rate for up to another 25 years.
Mario, problem is: with a 5-year CD you know your total returns today (the rate is fixed for 5 years), but with a Savings Bond, the rate is not fixed, so you don’t know how much you’ll get in 5 years. I still think Savings Bonds should not be compared to 5-year CDs; they are more like renewable 6-month CDs (since rates change every 6 months), so the 3-month penalty is totally out of date now (especially in view of the presence of so many high-yield online savings accounts).