Series I bonds versus bank CDs
Thursday, May 4th, 2006
Categorized as: Savings Bonds and competitive investments • Series I US Savings Bonds
It’s difficult to see how I bonds are a good deal when 1-year bank CDs are paying over 5%. Do you think the I bond “variable” portion truly compensates for inflation?
Series I Savings Bonds and bank CDs have some similar features, but the I bond has other features that bank CDs lack.
Unlike a bank CD, the I bond:
- protects you from the risk of inflation
- allows you to defer federal income tax on the interest you earn
- is exempt from state income tax
- pays interest for 30 years
CDs don’t have the inflation or tax features and aren’t normally available for terms longer than five years.
Although these features are more valuable to some people than to others, they do have value. Because of that value, I bonds should have lower rates than CDs. If they have the same rate, the I bond is definitely the better deal.
Each individual investor has to determine how valuable the features of the I bond are in his or her situation and make the choice.
Looking back 10, 25, 50, and 100 years, you’ll find the I bond inflation yield runs in the range of about 2.5% to 4%. If you’d like to have a better understanding of inflation, my book has a detailed look, including several graphs, that go back as far as 1800.
When you add that to the new I bond base rate of 1.4%, you get 3.9% to 5.4%. Over 30 years, tax-deferral can add .5% to 1.5% to the annual yield (the higher the yield of the investment and your tax bracket, the higher the tax-deferral yield).
You are also protected from hyperinflation, which is what happens to undeveloped countries that get mired in the kind of government, trade, and personal debt the U.S. is in. No one knows if that happens to developed countries or not.
Assuming you’re ok with the CPI as a measure of inflation, the I bond truly compensates for inflation over periods longer than a year, but because the rates change every six months some odd things happen.
For example, last November the I bond inflation component was 5.7% and now it’s 1.0%. Those combine into an annual rate of 3.35%, which is the rate of inflation over the whole year.
3.35% plus a 1% base rate give a yield of about 4.35%, which is competitive with what CDs were paying last November.
Likewise, today’s I bonds could be quite competitive with today’s CDs, but we won’t really know until October when we find out what the inflation component will be for their second six-month rate period.