I Bond rates go to zero

By Philip Brewer on 2 May 2008 (Updated 6 November 2008) 10 comments
Photo: Philip Brewer

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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Guest's picture
Michelle

Note that the EE bonds are also down to 1.4%, after being at 3.0%. This is really disappointing for those of us who were trying to give them as gifts.

Also note that the Fed cut interest rates another .25% recently, landing at a benchmark of 2.0%. This is good news for those who want to take out loans, but not so good for those of us who are trying to save up money.

I haven't been able to buy I bonds online yet, so I may just wait it out. (Long story involving they don't like the looks of me, who knows why, I have to get a signature guarantee, my local CU couldn't do it, the banks in town wouldn't do it for non-account-holders, so I had to open a bank account elsewhere and am now doing the wait-30-days-to-become-an-"established customer" game. Lucky for me, I'm smart and have infrastructure....)

Philip Brewer's picture

Yeah, none of these changes have been much good for the ordinary frugal person who's a saver rather than a borrower.  And, frankly, it doesn't even help borrowers much.  (Except for the Treasury and the banks--they're the ones who get to borrow at the new low rates.)

Guest's picture
Sarah

I was just debating whether to continue with I bonds, and you have just helped me make the decision.

Fortunately for Bush, Chinese investors will pick up any slack the loss of my modest contribution made.

Guest's picture
Yan

I was able to jump in on the train late April before the rate went to zero. The trick was to buy paper version via a local branch of Citibank, my primary bank. No wait, they did it on the spot since I already had my funds with them

Guest's picture
Jenny

What about the fact that the I-Bonds are guaranteed to match or beat inflation? CD rates aren't near inflation so you're losing money anyway but I-Bonds are guaranteed so that your $1 today will be worth $1 in the future economy.

Doesn't that make it worth buying?

I'm wondering about this because I buy a small amount each month (as a super-safe investment). I can't decide if I should continue buying them each month (and be at the mercy of whatever the inflation rate is for the next 5-30 years) or hold off for 6 months.

Will the Treasury bump up those bonds bought now to match inflation as they are guaranteed to do? Or am I missing something?

Philip Brewer's picture

Yes, if interest rates stay down but inflation stays high, then the I Bonds are winners.  I don't think that's the most likely scenario, but it's certainly possible.

One strategy would be to go ahead and get into I Bonds now, with an eye toward moving to other investments after rates go up.  You wouldn't be able to move the money until you'd held the bond for 12 months, and if you didn't wait at least 5 years you'd have to give up 3 months interest (that is, suffer the full effects of the last 3 months inflation), but that might well turn out to be a winning move.

Basically, an I Bond guarantees that you'll stay even.  That's better than falling behind, but it's not great.

At the moment, I'm betting that ordinary cash holdings, like money market mutual funds and internet savings accounts, will turn out to do better over the next year or five, even though they're doing worse over the next month or three.  I could well be wrong, though.

Guest's picture
getnolder

we bought I bonds in 2001 and 2003... the yield on the 2001 bonds is 6.08% since the beginning... on the 2001 bonds, it's 4.43%... the current rates, respectively 6.51 and 4.54.

certainly not a great return, but we looked at it as keeping the capital secure, being very afraid when Enron went down.

by next year, we won't have the 3 month penalty ( minor point, but several hundred dollars).

max bond buy is $30M per person per year.

big question, Phil, about the state of the market. you're probably right, but I see "real" problems with the money that's on the books in banks, pension funds, endowment funds, insurance funds, and the like... I don't think the money's there. As long as these funds carry unresolved securities as assets, I think they're at risk. the term "mark to market" equals "armageddon". so far, Bernanke et al, have dodged the bullet, and it's possible that if we have triple digit inflation, they'll bail out the debt by paying back in cheap dollars... but, ya have to remember that the '29 market didn't recover until 1954.

that 537 trillion dollars in derivative "notional" dollars... may not be what it sounds like, but it ain't smoke, either.

credit derivatives were supposed to protect the leveraged hedge funds and commodity accounts, but anyone who truly believes that this is happening, is still feeling good. reality is the great leveler.

I've been wrong for the past five years, so can't lay claim to being a guru, but for the life of me, can't imagine how we'll be back to the "normal" that the financial pundits claim.

Guest's picture
Guest

Although the fixed rate is 0 it appears that it return a higher
flexable rate than a bond bought year ago. Don't know why this
is done. If you look at the flexable rate of a 2008 i-bond you
will see it is higher than previouis year with it's 0 fixed
rate. ???

Philip Brewer's picture

Based on your comment, I can't be completely sure what you're describing, but I do have one notion:

The effective rate for an I-Bond changes every six months, starting when you buy it.  If the inflation rate is rising, then new bonds will include a higher inflation component to the rate, but old bonds will still include the lower inflation component until their 6-month anniversary, at which point they step up to the new rate.

You can see the details on the Treasury's page about I-bond interest rates.

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Donn Nemchick

Don't forget that the I Bond and EE Bond are exempt from most state income taxes and are a Federal income tax deferred investment. Combined that with they can be redeemed at any bank if you move from state to state they have inducements to hold on to them. No charge for replacements if they are lost or stolen as well! I am holding on to my $5000 worth of bonds purchased from 2000 to 2005. Won't buy any new ones however feel safe having a "rainy day" fund available if all else fails. Thanks for the information!