Series I Bonds November 2008 Fixed Rate: 0.7%

The new fixed rate for Series I Savings Bonds (“I Bonds”) was announced on Monday to be 0.7%. A few readers asked if I thought this was a good time to buy.

As a long-term investment, a 0.7% real yield makes I-Bonds a poor choice, as you can buy TIPS with much better yields. As of yesterday, a 5-year TIPS had a 3.66% real yield.

As a short-term investment, it depends on how you think inflation will turn out in the near future.

If you buy now in November, you will earn 0.7% fixed + 4.94% based on inflation = 5.64% for the first 6 months. The second 6-month rate will be 0.7% + a variable rate based on inflation from September 2008 to March 2009. So far, the markets seem to suggest that there is a decent possibility that there might even be deflation for this period. Reminders: You must hold for at least a year (or 11 months and a day if you buy on the last day of the month). If you hold for less than 5 years, there is a penalty of the last 3-months interest.

Worst case scenario, there is deflation of worse than 0.7% which makes the total rate zero for the 2nd six months. Earning 5.64% for 6 months with an 11-month holding period gives you only an effective 3.07% APY. If say, inflation is 1%, you’d get an effective 3.54% APY for the minimum 11-month hold. Even if this is exempt from state taxes, the tax-equivalent yield won’t be far above 4%. You can do better with bank CDs.

The only scenario where I-Bonds may be better than what you can get from a bank is if you think annualized inflation will be higher than 1.5% over the next 6 months. Personally, combined with the lack of short-term liquidity, I don’t think I’d take that bet right now.

For more background, see my last post on savings bonds.