I Bond rates go to zero
Since 1998, the US Treasury has had a pretty good deal for small savers who were worried about inflation--the Series I Savings Bond. The interest it paid was based on inflation plus an additional return that was set by the Treasury and fixed for the life of the bond. On May 1st the Treasury announced the value of that fixed return for the next six months: Zero.
In two recent posts both I (in Savers suffering as rates fall--what to do) and Xin Liu (in A Simple Guide to Series I Savings Bonds (I-Bonds)) praised the return on the I Bond that was available through the end of last month. The fixed part of the return was just 1.2%, but added to the inflation rate, it was quite competitive with other rates that savers could get.
Even with a zero fixed rate, inflation is high enough that the composite rate comes in at 4.84%. (That's the annual rate you'll earn over the next six months if you buy a bond this month.) If you think inflation is going to stay high and other interest rates available to savers will stay low, then the I Bond is still a good deal--it's tough to beat 4.84% on other secure, short-term savings vehicles. Even so, I think the savings bond is a loser at this rate.
If inflation comes back down, the inflation portion of this bond will shrink, reducing your yield. You can't cash the bond in during the first year, and if you cash it during the first 5 years, you pay a penalty of 3-month's interest. That makes the I Bond a loser if inflation comes down.
If inflation stays up, you have to figure that interest rates will eventually follow. So far, there have been plenty of investors willing to take interest rates that are below the inflation rate, but that's an unusual situation--an odd confluence of foreign investors with large amounts of dollars that they have to put somewhere, combined with the credit crisis making people so nervous that they're willing to accept low rates in exchange for safety. I don't think that will persist, though--and in any scenario where interest rates move up above inflation, the I Bond is a loser again.
The only scenario where the I Bond is a winner is if inflation stays up but interest rates stay down. That's been true for months now, and it's always possible that it'll continue to be true. If it stays true for a year or more, then the I Bond will be a winner. To my mind, though, that's not the way to bet.
This is the culmination of a tend that's run throughout the Bush presidency. The last fixed rate set by the Clinton Treasury (in November of 2000) was 3.4%, and at that time the inflation part of the rate was just 1.52%. Under Bush, the inflation part of the rate has risen substantially, and the fixed part has shrunk to zero. Giving the small saver a good rate is simply not a priority for the Bush Treasury.
If you've got an old I Bond, bought when the fixed rate was higher, be sure to hang on to it--you've got a sweet return locked in for a long, long time.
[Update 3 November 2008: There's now a new rate for the next six months: 0.7%.]
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