Tired of Low CD Rates? Try Savings Bonds

Yes, please!

Ok, I do like the idea of savings bonds, but this post is off-target. A year ago, you could have beaten bank interest rates, but this is not necessarily the case any longer.

If you buy a series I bond on Feb 26th, you will get 3.36% (annualized) for the first 6 months, so for February, March, April, May, June, and July. Yes, if you buy on the 26th, you actually get credit for having bought on the 1st. For the August-Jan timeframe, the rate will reset based on what CPI-U stands at after the March report.

The baseline from last september is 646.948, and as of January it is 649.098. We actually had DEFLATION from september-december, as the mark in december was 646.887.

So if CPI-U remains unchanged in the next two months, you would reset to 0.6647% annualized inflation plus 0.3% fixed for a combined rate of 0.9657% for the second 6 months.

After 12 interest payments (Feb 1, 2011) you can sell with a 3 month interest penalty. Meaning that in 339 days, you’ve earned 6 payments at 3.36% annualized and 3 payments at 0.9657% annualized (the last 3 are forfeited for early withdrawal), for a total return of about 1.911%, or 2.06% APY (remember, you held LESS than 1 year because of the quirk of purchases any time in the month being credited to the beginning of the month).

The best 1 year CD I see right now is 1.71%, so I bonds DO beat this, assuming that we do not have any deflation from now through March. If we do, you might make a mistake, as it could drop your interest for the last 3 months to $0, and your APY to 1.79%. Still better than the best current CDs, but maybe worse than where CDs are in a month or two.

This time last year, you could beat the best CD rates by a full percentage point over the course of the year, guaranteed. Today it isn’t so clear cut. Not a BAD investment choice, but not necessarily the best, either.

Bond Fan,

You missed the fact that from SEP-DEC, the first three months that matter for the rate reset, we DID have deflation. Long term will we have inflation? No doubt. But the 0.3% fixed rate portion I bonds currently carry is not particularly attractive. They used to carry 1-1.2% fixed rate portions, which makes them much more attractive…

But the question remains – will we have inflation in February or March or deflation? The latter remains a strong possibility. The producer price index has been indicative of deflation for 10 of the last 13 months. This is NOT a sign of inflation occurring anytime soon, unless it is driven by food or energy (those two were the entire reason for the VERY mild inflation we have have had since sep).

So you’re looking at this problem – I bonds are currently NOT likely to beat the best 12 month CD rates by much, if at all, for a 1 year investment term. You MAY get a much better fixed rate when the rates reset in May, making them a much more attractive investment. Since you are limited on how much you can buy in a year, you might want to wait until May to purchase.

Worry about inflation is a poor reason to buy I-bonds over CDs when inflation is VERY tame and we have actually had deflation recently, AND the fixed rate portion of I-bonds is lousy.

If they were offering 2% fixed, I would tell you that they were a great long-term investment, even if there was deflation now. But the rates just aren’t that attractive right now.

(BTW, I posted here LAST year that people should buy I-bonds over CDs, because there was a time when even with deflation for the reset portion, you were guaranteed a full percent higher return than for CDs)