Searching for the perfect investment
Thursday, May 25th, 2006
Categorized as: Savings Bonds and competitive investments
I’m looking for a solid tax-free investment. What do you think about Savings Bonds as a long-term investment, say 10 years? It seems the rates are lower than other options.
Tom’s response
Why a tax-free investment? Unless you are in the highest tax bracket, you’ll most likely earn more, after taxes, with a taxable investment. St Petersburg Times Personal Finance Editor Helen Huntley has explained this quite well. See my post, Do you really want a tax-free investment?
The only exception I would make to this would be a Roth IRA. If you are eligible for a Roth (there are income limits), you should put as much money as you can there before investing elsewhere.
Savings Bonds are free of state and local income taxes but they are taxable at the federal level. However, the tax can be deferred until you cash the bonds or they stop paying interest after 30 years.
Series I bonds in particular are as safe an investment as you can get - they protect you from the risk of default (that the bond issuer will go bankrupt), the risk of inflation, and the risk of capital loss (getting back less than you invested - with traditional corporate and government bonds, their value goes down when interest rates go up).
New I bonds pay 1.4% plus the inflation rate. Inflation tends to run at 2.5% to 4%, so over 10 years you can expect these to return 3.9% to 5.4%. And if it runs even higher, you’re protected.
When you buy fire insurance, it doesn’t mean that you expect a fire or that you want a fire. But you know fires have happened before, and you want to be protected. Likewise, when you buy a Series I bond, it doesn’t mean you want high inflation or that you expect high inflation. But you know high inflation has happened before and you want to be protected.
That protection isn’t free and that’s why I bonds don’t pay the highest rates around. Nonetheless, Series I Savings Bonds are the best place to put money you can’t afford to lose. It’s the only investment that guarantees you’ll get back more than you put in after accounting for inflation.
My book, , has a lot more details on Savings Bonds in general and the unique advantages of Series I bonds in particular.
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Tom Adams