savings bonds

8 Money-Smart Things I Wish I'd Asked Santa For

Mikey Rox — Fri, 16 Dec 2016 11:00:09 +0000

I spent a couple of decades asking Santa Claus for toys, clothes, and gadgets galore, but I don't have a single thing to show for it — I mean, besides a basement full of outdated stuff. Instead, I should've begged Ol' Saint Nick for these eight things that would have paid for themselves over and over again — so I could afford an even bigger basement full of outdated stuff. Take a look:

1. An Impenetrable Credit Score

When I turned 18 and the friendly lady at Discover Card called to ask if I'd like my very own credit card, I enthusiastically said yes. I generally consider that my very first adult mistake. Not that credit cards are bad, but they're the devil in the hands of a financially irresponsible college freshman. Because not only did I max the card out in less than six months, I was unaware that not paying the bill for five years thereafter would result in a disaster of a credit score when I entered the "real world." If only Santa could have done me a solid by fortifying my credit score — against myself.

2. Everything Gold

In 2006, I asked Santa Claus for things like seat covers for my vehicle and a new digital camera because that's what materialistic 25-year-olds in major credit card debt ask for. Instead, I should've asked for straight-up gold bars. Heck, I would've been happy with a few flakes — like this guy who got away with 86 pounds of jeweler's "bench sweeps" worth $1.6 million. Because 10 years ago, on Dec. 11, gold was valued at $625.81 per troy ounce. Flash forward a decade and the price has nearly doubled to between $1,100 and $1,200, depending on the day, and that's really just midrange. On Sept. 12, 2011, gold hit its 10-year high of $1,861.49 per troy ounce, which — if you were feeling lucky that day — raked in three times its original amount if you unloaded a few bricks.

3. EE Savings Bonds

Hardly anybody gives savings bonds as gifts anymore (well, except maybe your grandma) because what fun is a certificate that you have to hold on to for, like, ever to reap its benefits? But just because they're not as popular as they once were doesn't mean they're not still valuable — if you got in on them in the 1980s and '90s, that is. EE bonds issued in the 1980s had rates of return of 6% to 9% a year, compared to today's 0.1% annual fixed rate. Mathematically, if you have a $500 bond from June 1983, for instance, it reached full maturity in June 2013, with a value of $1,014.40. Santa, can you hear me?

4. Real Estate in Depressed Markets

Throughout my years living in major cities like Baltimore and NYC, I've heard legendary tales of beautiful row houses and brownstones in economically and socially depressed areas, like Federal Hill in Baltimore and Harlem in New York City, that sold for crazy-low prices like $1. The $1 price is probably a myth, but dilapidated properties have in fact gone for very affordable prices with agreements that buyers reside in their neighborhoods for a specified period of time. I personally know a few people who purchased homes in blighted areas for around $30,000 20 years ago and are now sitting pretty on $2+ million lots.

5. College Tuition

All I needed was a cool $100K, Santa. I would've paid my college tuition and room and board outright so I didn't have to make up for half that amount myself over the next 20 years after graduating. Alas, I'm halfway there, and I've paid two of three notes off, but if you could cut a check for the rest this year, I'd appreciate it.

6. A Trust Fund

My financial woes would be nonexistent if I had asked Santa for a generous trust fund at an early age. Then I'd be just like the rest of my friends who were lucky enough to be related to someone filthy rich — free of debt with plenty of time to take selfies on a beach and dedicate my life's work to my own liver replacement.

7. Guaranteed Employment

There's nothing more stressful than job hunting, and I'm thankful that I haven't had to do that in a while since I'm self-employed. But self-employment isn't easy, either. I'm responsible for my own income instead of enjoying that twice monthly direct deposit for just showing up at my desk five days a week. Still, even that's on shaky ground if you don't mind your Ps and Qs — a friend of mine was recently laid off two weeks before Christmas — so this year I'd like to ask the big guy to make sure everybody can get (or keep) the job they really love for a happy and prosperous 2017.

8. Winning Lottery Numbers

I rarely play the lottery, but I do spend a few bucks when Mega Millions is, like $300 million, because, hey, somebody has to win. If that ever happens, my friends, you'll never hear from me again. Ev-er. Send me those winning numbers, Santa!

This article is from Mikey Rox of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

10 Places to Stash Your Money Besides a Savings Account

Damian Davila — Tue, 10 May 2016 09:30:24 +0000

The long-awaited interest rate hike from the Fed finally arrived on December 16, 2015. But as of May 2016, it still hasn't affected the interest rate of most savings accounts. The national average savings account interest rate currently stands at a measly 0.06%, according to data from the Federal Deposit Insurance Corporation (FDIC). And some brick-and-mortar banks are offering rates as low as a pitiful 0.01%!

There are far better places to park your hard-earning savings. Let's review 10 places to stash cash besides a traditional bank savings account.

1. Online High Yield Savings Account

With the Internet taking over pretty much everything, it's not a surprise that it has also taken over banking. By putting your funds in an online savings account, you'll have access to higher yields. As of April 2016, you can find high-interest savings accounts with yields ranging from 0.75% with the Capital One 360 Savings Account, to 1.05% with the Synchrony Bank High Yield Savings Account. Make sure to read the fine print, though, because they may require minimum deposits and limit the times you can access funds per month. (See also: 5 Best Online Savings Accounts)

2. Certificate of Deposit

By tying up your money for a longer period of time, banks and credit unions are willing to offer you a higher interest rate. With terms ranging from one to 60 months, a certificate of deposit (CD) is a financial vehicle insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account per depositor. Certificates of deposit can easily beat that 1.10%. For example, a credit union in Honolulu, Hawaii is currently offering 16-month and 60-month CDs with a 1.20% and 1.78% APR, respectively.

3. Series I Savings Bond

Backed by the full faith and credit of the U.S. government, Series I Savings Bonds (also referred to as "I Bonds") are adjusted for inflation every six months so the purchasing power of your savings stays intact. Earnings are exempt from state and local taxes and can be entirely tax-free when used for qualifying post-secondary education expenses. I Bonds are available on small denominations starting at $50 and can be bought online via TreasuryDirect or through your tax return using Form 8888, Allocation of Refund (Including Savings Bond Purchases).

4. Gold

For a long time, several countries, including the U.S. and the U.K., committed to fix the prices of their domestic currencies in terms of the market value of a specified amount of gold. Even though the market price of gold has proven to be quite volatile, it still could work as a good way to stash your savings, depending on your timing. When it comes to gold, history has proven that it's best to buy and hold for a long time. On May 1, 2006, the price of gold per ounce was $670.30 and on April 18, 2016, it was $1,245.68. That's a 85% total return for about 10 years. This is why investors still use gold to hedge against uncertainty and inflation.

5. Exchange Traded Fund for Precious Metals

Of course, buying and selling coins, bars, or privately minted coins of gold and silver requires skill, storage space, and knowledge of the commodities market. An alternative way to put your savings in gold and silver is to buy an exchange traded fund (ETF) that tracks the market price of those precious metals. Some examples include the iShares Silver Trust [NYSEArca: SLV], SPDR Gold Shares [NYSEArca: GLD], ETFS Physical Silver [NYSEArca: SIVR], and iShares Gold Trust [NYSEArca: IAU].

6. Lego Sets

If the investment returns from gold impress you, wait until you hear that of Lego Sets:

Imperial Star Destroyer was worth $249.99 in 2002 and today is worth about $2,185 (return: 774%)
Death Star II was worth $372 in 2005 and today is worth about $2,270 (return: 510%)
Taj Mahal was worth $134 in 2007 and today is worth about $2,753 (return: 1,954%)

Of course, you'll have to do some research to identify the most promising sets. With about 80 stores in the U.S., you'll have plenty of opportunities to play… ahem!... I mean, research.

7. Discount Gift Cards at Costco

Bulk buying 170 oz. detergent jugs and $4.99 roasted chickens aren't the only ways to let your dollar go the extra mile at Costco. You can stash your savings in discounted gift cards. For example, you can currently get two $50 gift cards for Buca di Beppo for $76.99 ($74.99 plus $2 for shipping and handling) at the Costco website. By planning out your purchases of discount gift cards for restaurants and other retailers, you can get a better return than that of a savings account.

8. Christmas Club

Another alternative to savings accounts is the Christmas club, which will hold money put aside for future holiday spending. Also known as Christmas savings accounts, Christmas clubs are available at over 70% of U.S. credit unions. By committing to hold your funds in the account for a predetermined period (e.g. November 1st), a credit union will pay you a higher interest rate than that of its regular savings account. The catch is that if you withdraw the funds before the deadline, you'll be charged a steep fee that nullifies all your interest gains. (See also: 9 Good Reasons to Choose a Credit Union Instead of a Bank)

9. Peer-to-Peer Lending

Banks make a profit by taking your deposits and offering those monies as loans to other individuals at a higher interest rate. You, too, can take a crack at profiting from lending through peer-to-peer lending at sites including Prosper and Lending Club. With a minimum investment of $25, you could start investing in loans with an average annual interest rates ranging from 5.23% to 9.11%. By sticking with the highest grade of investment loans, you have a good chance at beating the annual percentage yield (APY) of any savings account.

10. Secured Credit Card

While secured credit cards can be useful to building or repairing your credit history, some of these cards also allow you to gain interest on your security deposit. If you're considering to apply for a secured credit card, getting one that lets you make money on your secure deposit would let you kill two birds with one stone.

What are other great places to stash away your savings?

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

6 Smart Ways to Use Old Savings Bonds

Qiana Chavaia — Tue, 30 Dec 2014 14:00:13 +0000

Still hanging on to those old savings bonds your grandparents bought for you when you were a kid? If so, you're probably wondering what to do with them and how much they're worth.

Savings bonds are debt securities issued by the U.S. Treasury Department. If you own paper bonds, they are likely Series E, EE, or Series I Bonds, which in the past 30 years earned roughly 3.5% to 7.5%. If you're interested in calculating the face value of your bonds, use the Treasury Direct online calculator. Or, use the Treasury Hunt tool to determine if you were ever the beneficiary of a bond you don't know about. (See also: Receiving Your Tax Refund in Savings Bonds)

Once you know what they're worth, here's what you can do with your old savings bonds.

1. Hang on to Them Until the Maturity Date

Savings bonds were designed for long-term savings, so if you don't need the money now, you should hold on to your bonds until they mature before cashing them in. The maturity date is at least five years from the date of issuance and up to 30 years (the maturity is listed on your bonds). However, Series E/EE Bonds can be redeemed after one year and Series I Bonds after just six months. The early redemption penalty for cashing them within the first five years is forgoing the last three months of interest.

2. Convert Them to Electronic Savings Bonds

As of 2012, paper bonds are no longer available. Using TreasuryDirect's Smart Exchange you can convert your old paper bonds into electronic bonds by simply following the getting started resources on the website. This allows you to keep track of and manage your bonds online, plus it enables you to make any future bond purchases easily electronically. And it'll save you some time and hassle in the future when you choose to redeem your bonds.

3. Cash Them in and Invest

The best thing you could do is put your money straight back to work for you. After cashing in your bonds, reinvest the capital in the stock market. If your bonds are less than 30 years old and are still earning interest, they are likely underperforming the average annual stock market return. But unlike stocks, bonds are low-risk investment. To minimize some risk while still taking advantage of the stock market, consider investing in ETFs and mutual funds through your Roth IRA.

4. Pay for College, a Certificate, or Vocational Training

Cash in Series EE and Series I bonds issued after 1989 to pay for qualified education expenses, and you won't pay income tax on earnings. Educational expenses include all tuition and fees, including room and board, course materials, and other fees. Expenses can be for yourself, a child, spouse, or relative.

5. Locate Tax Records

If you were the recipient of a savings bond with or without a parent or grandparent listed as the beneficiary, to avoid income tax on accrued interest, the co-owner may have filed a federal income tax return for you as a child, in order to report investment earnings. And, because you were a child who did not cross the earned income threshold for filing a return, no tax would be due. Upon redemption of your savings bonds you would only owe tax for the current year's accrued interest.

6. Convert Them to TIPS

Treasury Inflation Protected Securities (TIPS) are exactly what they sound like: Bonds designed to keep pace with inflation. Unlike the traditional savings bonds you may be holding, their value adjusts with the inflation rate, so that their worth is not eroded over time. Selling your traditional bonds and using the proceeds to acquire TIPS, instead, might protect your capital better from inflation.

Do you have old savings bonds? How do you intend to use them?

This article is from Qiana Chavaia of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Receiving Your Tax Refund in Savings Bonds

Thursday Bram — Fri, 04 Mar 2011 12:00:30 +0000

As you prepare your tax return this year, you have an interesting option. You can opt to receive part of your tax refund as U.S. Savings Bonds. The process is relatively simple. Form 8888 (PDF) from the IRS allows you to allocate how you will receive your refund. You can have your refund directly deposited into a bank account, mailed to you as a check, or invested directly into savings bonds. You can also divide your refund between these options however you'd like. It's an easy process. The real question is should you invest part of your refund into savings bonds.

The bonds in question are Series I Savings Bonds, which the U.S. Treasury sells for face value. You can redeem such a bond, plus the accumulated interest on it, after twelve months have passed — although if you redeem a bond you've held less than five years, you'll give up three months worth of interest. Series I Bonds earn a combination of a fixed rate and an inflation rate. The fixed rate stays the same for the life of the bond, while the inflation rate changes every six months. New rates are set every November and May. The last fixed rate set (November 2010) is 0.00 percent, which means bonds bought before next May will be relying entirely on their inflation rate for income. You can see a list of recent rates on the U.S. Treasury's website. (See also: While Waiting for Rates: I-Bonds)

The Benefit of Automatic Savings with Bonds

Sarika Abbi, who works with the D2D Fund to encourage savings for low-income consumers, points out that this approach provides a way to automatically save money.

The nice thing is a taxpayer can consider saving just a portion of their refund with bonds, allowing them to use the remainder to pay bills, meet spending needs, or save in other saving or investment vehicles. For individuals who don’t have access to savings, it’s a great way to begin setting some aside for the future, without the requirement of a bank account. They also offer a competitive rate in comparison to comparable savings products (traditional savings account and one-year CDs). There are no fees associated with buying or redeeming bonds and they have a low entry point: only $50. This makes them a very accessible product for many households.

Tax-time saving bonds are Series I Savings Bonds, which are inflation-protected. This means your savings bond never lose value. They are also very safe investments — your principal is protected and when you redeem them you will receive your entire principal as well as any interest earned. They are a nice long-term vehicle (mature in 30 years) but are accessible one year after purchase if a family faces an emergency or need for the vehicle. It is also a good savings vehicle for individuals who want to set money aside for their children, grandchildren, or other loved ones. And there is a tax break if used for education purposes.

It's truly an easy way to build up savings, and the fact that it takes a little more work to cash in a bond than it takes to just transfer money out of a checking account means that there's an additional barrier to using your savings for purchases that aren't really all that necessary. There is a maximum amount that you can invest in Series I bonds every year — $5,000 — but a taxpayer can request as little as $50 in bonds if that's all someone wants to put aside.

Is Getting Your Refund in Savings Bonds Right for You?

It's true that savings bonds, especially at current interest rates, aren't the ideal investment for everyone. But when you consider that you can use them as a savings vehicle rather than an investment opportunity, you may find that putting part of your income tax refund towards savings bonds makes sense. You may find that you can earn at least as much interest as you can through a savings account at your bank. And if you're starting to plan for college for a little one, a savings bond offers other benefits over the typical bank account.

This article is from Thursday Bram of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

While Waiting for Rates: I-Bonds

Philip Brewer — Mon, 28 Feb 2011 13:00:09 +0000

Your short-term cash in a savings account or money fund isn't earning much yield. You could earn a bit more by locking your money up for a longer term, but that could be costly if your money is still locked-in when rates eventually do rise—and especially costly if inflation goes up.

If only there were some instrument that paid a reasonable return, provided some inflation protection, and still gave you access to your money if rates went up.

As you'll have guessed from the title, there is: the series-I savings bond.

The I-Bond provides excellent inflation protection, by paying a rate that consists of a portion that's fixed for the life of the bond, plus a portion that changes every six months based on recent inflation. A bond you buy right now will only pay the inflation rate, because the fixed portion is zero. However, there'll be a new fixed rate announced May 1st.

The I-Bond does this while providing considerable flexibility for you to decide how long you want to leave your money in. If it's providing a good return, you can choose to leave your money in for 30 years. Alternatively, you can take your money out any time after one year has passed. If it's been less than 5 years, you forfeit the last three months interest payments—but since rates are so low, that's not much of a penalty.

Four Scenarios

There are four scenarios that you need to consider: interest rates might stay low or they might go up; at the same time the inflation rate might stay low or it might go up. Let's look at each of those in turn, and see how the I-Bond works in that scenario.

Rates stay low, inflation stays low

This is basically the situation we've been in since the financial crisis began. The I-Bond is an adequate investment, keeping you even with inflation.

Your best move: Hold your bonds. With low rates, you probably can't do better elsewhere anyway.

Rates go up, inflation stays low

This seems like the least likely scenario, but if this is what happens, you'd be okay.

Your best move: Cash in your bonds and then invest in something paying the new higher rates. You'll have to give up three month's interest—but since inflation is low, that wouldn't be much.

Rates stay low, inflation goes up

This is generally the worst situation for the saver, but the I-Bond does a reasonably good job of protecting you, and you can't do much better elsewhere anyway. (People who locked in their money at low rates without inflation protection, on the other hand, are screwed.)

Your best move: Hold your bonds and keep up with inflation.

Both interest rates and inflation go up

In this scenario you're protected from the inflation, but you're not earning the new higher rates.

Your best move: Cash in your bonds. You'll pay a penalty, but it will be small (as long as you do it early, before you'd earned much of the new, higher inflation adjustment). Then reinvest at the higher rates.

Take Your Time

Probably the best move overall is to adopt this strategy gradually. For one thing, since you can't get your money out for the first year, you don't want to put in any money that you might need during that time. In any case, you're only allowed to buy $5000 worth of savings bonds per year anyway.

If you make a modest investment into I-Bonds each year, all but the most recent batch will be available to cash in anytime that's the right move. And, once five years have passed, some of them will be available to cash in with no penalty.

In fact, once you reach that point, you can start thinking of your savings bonds as part of your emergency fund. They can be cashed in at any bank, so they're almost like cash. (But they're more secure than cash, because if they're lost, stolen, or destroyed, you can get them replaced.)

If you want to invest larger amounts, consider TIPS. They're currently paying higher rates. (However, they don't have the feature of allowing you to cash them in early.) I wrote an article comparing TIPS and I-Bonds a while ago.

See the Treasury's site on I-Bonds for all the details on current rates, how the rate is calculated, how to buy them, etc.

It's entirely possible that interest rates will stay low. In fact, the Fed is pretty much promising to keep rates low for "an extended period." That's assumed to mean at least six months, but it could be much longer than that. I-Bonds are a reasonable choice while you're waiting—and after May 1st, depending on what the Treasury sets as the new fixed rate, they might get better.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Savings Bonds as Interest-Earning Travelers Checks

Philip Brewer — Sun, 08 Nov 2009 14:00:01 +0000

Remember travelers checks? In the days before ubiquitous automated teller machines, they were a useful product. You could use them almost like cash — but you could carry more than you'd feel safe carrying in cash because if they were lost or stolen you could get them replaced. Well, savings bonds have all those features but one.

The thing you can't do with savings bonds is spend them like cash; you have to cash them in at a bank. (But then, I've sometimes had to cash travelers checks at a bank too.) In the US, pretty much any bank will cash US savings bonds. I assume there's something similar in other countries.

I first noticed this feature in the early 1980s — back before networked ATM machines made it easy to access the money in your accounts from anywhere you happened to be. Travelers checks were a useful tool for carrying your cash. But, when I noticed that several of their key features were shared with savings bonds, I started buying savings bonds instead — they paid interest. And I wasn't the only one. Anybody who needed to move around a lot — for example, military personnel — found them just as useful.

Basically, what you do is this: Buy savings bonds in small quantities over a period of time. This is easy to do; many employers let you buy savings bonds through payroll deduction and many banks will set up automated purchases as well. You can get them in all the denominations that you can get travelers checks and then some: $50, $75, $100, $200, $500, $1,000, and $5,000.

You can't cash the bond in until you've held it for a year, which is why I suggest buying gradually — you wouldn't want to put your whole emergency fund into savings bonds all at once. But, if you buy one every pay period or every month, pretty soon you'll have some that are more than a year old. Once that happens, they're basically just like travelers checks that you can only cash at the bank.

Go into pretty much any US bank with one or a few savings bonds (up to $1000 worth), and you can turn them into cash in just a few minutes. If they're lost or stolen or the paper certificate is damaged, you can get it replaced.

I've been enamored of savings bonds for a long time, but haven't talked about using them this way before here on Wise Bread, because they haven't had a competitive interest rate. Now, though, the rate on I bonds is looking pretty good.

As I mentioned back in July, the Consumer Price Index is about to surge. This isn't because inflation is rising (although I rather expect that to happen as well), it's just because it's now been a year since the big drop in oil prices.

The interest rate paid on I bonds is based on the CPI for the previous six months, so the effect of the oil price drop has already fallen off the calculation. Bonds purchased now will earn interest at a 3.36% annual rate for the next six months. That's a hard rate to beat in the current environment.

There's a 3-month interest penalty if you cash them in during the first 5 years, but even if you end up paying the penalty you still come out ahead compared to most vehicles for small savers. And if inflation rises (as I rather expect it to), the return just gets even better. Combine that with the features that make them like an interest-paying travelers check, and I think they're a pretty good buy right now.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

New rate set for series I savings bonds

Philip Brewer — Mon, 03 Nov 2008 20:07:11 +0000

Every six months, the Treasury sets a new fixed rate for series I savings bonds. After tracking close to the rate on the Treasury's other inflation-indexed bonds during the Clinton administration, the rate was cut sharply starting in 2001, culminating in an interest rate of zero for the past six months. Today, though, the Treasury announced the new rate for the next six months: 0.7%

That rate isn't as bad as it sounds, because you get that plus inflation. Adding in the adjustment for inflation, the total annual return on a bond purchased this month will be 5.64%. (That's an annual rate that will apply for the next six months. A new rate, based on inflation, will be calculated every six months--but the 0.7% fixed part of the return will remain in effect for the life of the bond.)

There are several good features of the I Bonds. You can defer taxes on the interest until you cash the bond--up to 30 years. And, if you use the money for education expenses, you may not have to pay taxes on it at all. In addition, if there's deflation, your investment is protected to the extent that its value won't fall below the face value of the bond.

As an alternative to the series I savings bond, consider TIPS--Treasury Inflation Protected Securities. They pay a market rate determined at auction, rather than a fixed rate determined by the Treasury. Currently, they're paying as much as 3.25% (plus inflation). Obviously, that's a lot better than 0.7%. There are several downsides, though. In particular, new bonds are only issued on specific dates (although you can buy one at any time through a broker). Also, TIPS have a specific maturity date, and you can neither cash them in early nor hold them longer, the way you can with a series I savings bond. In addition, their protection from deflation isn't quite as good. (For more info, see my previous article about TIPS and I Bonds, and for information on the mechanics of buying them, see my article Treasury bills for ordinary folks.)

Inflation plus 0.7% isn't a great rate, but given that there's a real danger of the economy tipping toward either inflation or deflation (or first one and then the other), these bonds may be a good buy.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

I Bond rates go to zero

Philip Brewer — Fri, 02 May 2008 14:47:57 +0000

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%.]

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Savers suffering as rates fall--what to do

Philip Brewer — Fri, 04 Apr 2008 13:33:36 +0000

Interest rates for ordinary savers held up pretty well after the first Fed rate cut in July last year. There was a simple reason--banks needed the money. With the credit squeeze making it tough for banks to raise cash, the last thing they wanted was for savers to draw their money out in search of higher returns. The Fed's efforts to relieve the squeeze have been somewhat successful--banks have substantially cut the rates they'll pay savers.

The first graph shows the Effective Fed Funds Rate (blue) versus the rate that I've been earning on my ING Direct savings account (red). (I picked the ING rate simply because it's one that I happened to have data for. The Fed Funds and mortgage rate data are from the St. Louis Federal Reserve.) As you can see, the savings account rate held steady for a couple of months after the Fed Funds began to drop, and even after it began to fall, fell more slowly.

The rates actually crossed over in December, with the Fed Funds rate falling below the savings account rate.

Still, with the Fed driving rates lower and lower, the rate paid to savers dropped steadily. The 4.5% that ING was paying last summer has fallen to 3%.

As an aside, it's worth noting that the rates that bank charge have scarcely dropped at all. The green line tracks the average rate for a 30-year conventional mortgage, which has barely budged over the past year.

Given this, what's a saver to do? Well, shopping around for better rates is always worth doing. There are banks paying more than ING Direct. It's also worth considering other savings instruments.

As an example of the latter, consider savings bonds, and in particular, the I Bond. It pays a complex variable rate based on the Consumer Price Index. Some people dismiss it, knowing that the CPI substantially understates inflation. That's a mistake. Instead of comparing the I Bond to the inflation rate, you need to compare it to other rates available to savers.

The way the I Bond works, there's a fixed rate to which is added an inflation rate (basically, the CPI). The fixed part doesn't change once you buy your bond; for the rest of this month, it's going to be 1.2%. The inflation rate changes every six months, based on the CPI for the preceding six months.

We know what the combined rate is for the rest of this month: 4.28%. If you buy a bond this month, you'll keep the same 1.2% fixed rate for the lifetime of the bond. We also know that the growth in the CPI for the past six months will almost certainly be as high as the growth in the preceding six months, so you can be reasonably confident of getting as good a rate for the next six months as you're getting for the first month. After that, rates will vary--but I don't think you need to worry about the rate of growth in the CPI dropping so low as to make an I Bond uncompetitive with an ordinary CD or savings account any time soon.

So, how do I Bonds stack up compared to CDs or savings accounts? Well, one big difference is that you can't get your money back for a year. Once a year has passed, you can cash your bond in any time you want, but if you cash it in before 5 years are up, you lose 3 months interest. Taking that penalty into account, an I Bond is roughly as good as a 1-year CD that pays 3¼%.

The big win for I Bonds comes when you really don't know how soon you might need the money. You have to be confident that you won't need the money for a year, but after that you can decide month-to-month whether the I Bond is the best choice. If those months add up to 5 years, the 3-month interest rate penalty goes away and the bond just gets better.

Because you don't know the future (regarding either interest rates or your future needs for money), one thing to consider with savings bonds is buying them in small amounts over time. You can buy an I Bond for as little as $50 ($25 if you buy them electronically via TreasuryDirect). That makes it easy to manage the one-year wait before you can cash a bond in--buy very modest amounts at first. If the interest rate remains competitive, buy more later.

Two other details:

There's a special tax provision that lets you defer taxes on savings bond interest until you cash the bond in. (And, like any US government security, the interest is free from state income taxes.)
Savings bonds pay interest from the first of the month, no matter when in the month you buy them. So, by buying them near the end of the month, you can pick up almost one month's interest immediately.

If you're struggling to find a reasonable return for your savings, and you've got some money that you can safely tie up for a year--especially if there's a pretty good chance that you won't need it for another five years--the I Bond is a reasonable choice. It's quite a bit better than most bank CDs.

Update: As I feared, this deal was too good to last. On May 1st, the Treasury announced the new fixed rate for the next six months: Zero

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

TIPS and I-Bonds

Philip Brewer — Sun, 02 Sep 2007 11:32:27 +0000

There are risks in any investment. The market might go down--or the market might go up, but your investment might go down anyway. The company that issued your stock or bond might go bankrupt. Even cash has the (virtually certain) risk that it'll be worth a bit less next month due to inflation. There are a couple of investments that eliminate almost all these risks: TIPS and I-Bonds.

Having just talked about gold as an investment, I thought this might be a good time to talk about these other inflation hedges.

In some ways these securities are pretty similar. They're both issued by the US government and they're both indexed to the Consumer Price Index. Although the details of inflation adjustment are quite different, the results are pretty similar.

They don't eliminate all risks, of course. The calculation of the CPI could understate inflation (it probably does, although not by a lot). The inflation rate that matters to you--the rise in costs of the goods and services that you buy--could be higher (or lower) than the government's calculation, even if the goverment's number fairly represents the average inflation faced by the average person. The US government could collapse. Overall, though, these investments are about as safe as cash and offer a higher return.

TIPS (Treasury Inflation Protected Securities)

These are a lot like other treasury notes and treasury bonds. They're sold with a face value of $1000, and the interest rate is determined in an auction. Individual purchasers can skip the auction process and just buy at the auction price (which guarantees you the same return as the investment professionals whose bids won the auction).

The interest rate is usually pretty low (currently running around 2.3% to 2.4%), which is not as bad as it sounds, because it is paid on the inflation-adjusted face value of the bond. An adjusted face value is calculated for each day and is announced monthly when the new CPI numbers are released. For example, the face value of the 3% 10-year TIPS that was auctioned in 2002 was 1158.80 on September 1st. As long as inflation continues, the face value will go up--and the interest payments, calculated as a percentage of face value, will go up as well.

At maturity you get the final adjusted face value. The face value won't go below $1000, giving you some protection against deflation as well.

If you have to sell before maturity, though, you're not guaranteed the face value. The price will depend on current interest rates and current inflationary expectations.

I-Bonds

These are savings bonds, rather like ordinary savings bonds. They're sold in various denominations, from $25 to $10,000. They also pay a fixed rate plus an inflation adjustment, but the calculation is different. Instead of calculating an adjusted face value and then applying the fixed rate to that, the treasury calculates a "composite earnings rate" that combines both parts. The composite rate is calculated every six months, based on the inflation rate of the previous six months.

The fixed part of the rate is determined by the Treasury twice a year. It applies to all bonds sold for the next six months, and remains in effect for the lifetime of the bond (30 years).

You can't cash in an I-Bond in the first 12 months after you buy it, and if you cash it in after less than five years, you lose 3-months of interest.

After-inflation return

Back when inflation-adjusted bonds were new, they paid a pretty good rate. If you'd bought one in 2000, you could have gotten a 10-year TIPS that paid 4.25% over inflation. Until about 2003, you could generally get 3% over inflation. Since then, the rates have dropped, mostly because interest rates in generally are lower now.

One way to think about the rate on a TIPS is that it should be exactly the same as the rate on an ordinary treasury security of the same maturity minus the expected inflation between now and then. So the rate on a TIPS goes down anytime the expected inflation rate goes up, plus it goes down anytime other interest rates go down.

The rates on I-Bonds used to be reasonably competitive with the rates on TIPS (from 1998 until 2001 they were 3% or higher). Since then, though, they've fallen quite low. The current fixed rate on an I-Bond is just 1.3% over inflation.

Tax Considerations

One reason to consider I-Bonds, despite the very low rate, is that they've got the same tax advantages of other savings bonds. You can choose to pay taxes on the interest every year (if, for example, you're a child with almost no income who will owe no tax) or you can chose to wait and pay taxes on the income only when you cash in the bond. Further, if you use the money to pay for certain kinds of education expenses, you don't need to pay taxes on it at all.

TIPS, on the other hand, have a unique tax problem: you not only owe taxes each year on the interest that you get, you also owe taxes on the increase in face value due to inflation (even though you don't actually get that money until the bond matures). Some people consider this a big deal, and don't recommend that you buy such bonds except in a tax-sheltered plan such as an IRA or a 401(k). Personally, I don't see how it's much worse than the tax treatment of a mutual fund where you're reinvesting the dividends, where you still owe taxes on the dividends and the capital gains, even though the money has been reinvested in the fund.

The interest on TIPS and I-Bonds, like all US Treasury interest, is exempt from state and local income taxes.

Info on:

TIPS
I-Bonds

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: