Well, the CPI-U that I recently questioned went up 0.9% in March alone. I guess you can’t hide everything. 😉 So, is it time to buy some Series I bonds? First, refer back to this earlier post for a primer as well as some background information. You can ignore the predictions since we have the actual data now.
Calculating the Rates For Next 12 Months
If you buy by the end of April, the fixed rate portion of I-Bonds will be 1.2%. You will be guaranteed an variable interest rate of 3.08% for the next 6 months, for a total interest rate of 4.28%.
After that, the rate will adjust every 6 months based on the previous 6 month’s worth of inflation data. The next adjustment will be in May, based on September-March 2008 data. We can effectively predict this now using the prediction method explained here:
Sept 2007 CPI-U was 208.490. March 2008 CPI-U was 213.528. 213.528/208.490 = 1.02416, or a semi-annual increase of 2.416%.
Total rate = Unknown fixed rate + 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)
If we assume a fixed rate of the current 1.2%, we get
Total rate = 0.012 + (2 x .02416) + (.012 x .02416)
Total rate = 1.2% + 4.86%
Total rate = 6.06%
Possibly Good Short-Term Investment?
A known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. Let’s say we buy at the end of April, hold for the minimum of one year, and pay the 3-month interest penalty for redeeming within 5 years. You’ll be able to sell on April 1, 2009 for an actual holding period of 11 months.
We will get 4.38% for 6 months, and ~6.06% for 3 months taking in account the penalty. Over 11 months, that’s equivalent to an annual rate of ~4.04%. Now, if you live in a state with 9% state income tax, your equivalent yield gets bumped up to ~4.44% depending on if you fully itemize your state income taxes.
This is a pretty competitive yield for an 11-month term on guaranteed cash, as long as you are okay with the lack of liquidity. In addition, you can always decide to hold it longer than 11 months if inflation continues to climb and the Fed is unwilling to raise interest rates due to economic recession. This could make your Series I bonds yield significantly more than similar bank CDs. If you hold for 5 years, then you don’t have to pay the 3-month interest penalty either.
Update: Also, if you hold it for 15 months (14 with buying early), you would get 4.28% for 6 months, 6.06% for 6 months, and then 0% (penalty) for 2 months. This would average out to about ~4.43% APY over that slightly longer period.
Very little downside with a good potential upside… just how I like it! I’m definitely buying some, I just have to figure out how much cash I am willing to lock up for 11 months.
The Catch
First of all, I just tried and unfortunately the TreasuryDirect website no longer allows purchases over $5,000. The official (and now enforced) purchase limit is $5,000 of paper I-bonds and $5,000 of online I-bonds per Social Security Number, per year. For a couple, that’s $20,000 total per year.
Second, you need to be quick and buy before the end of April to lock in these rates. I have a feeling in May the fixed rate will drop significantly. So if you haven’t already, open your account at TreasuryDirect soon. Their security has increased, I couldn’t even link up a new bank account online without mailing in paperwork. For paper bonds you should be able to buy these at any bank (not sure about credit unions).
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Good post! I’ve also been keeping tabs on the CPI-U with an eye on buying I bonds, and just posted my own analysis/calculations as well.
One thing to consider is that since the second 6-month period has the much higher rate (I calculated 6.07%, a rounding difference), a better strategy would be to hold the bond for 14 months rather than 11. This takes full advantage of the 6.07% rate, and forfeits 3 months at the (currently unknown but probably lower) Nov 2008 rate instead.
Something to think about! 🙂
Also, it’s important to note that the fixed rate at time of purchase is good for the life of the bond. So, the fixed rate for the 2nd 6 months will definitely be at 1.2% (assuming the bond is purchased in April), rather than the currently-unknown fixed rate that will be published on May 1.
Countrywide and Indymac are still offering 4.1-4.2% 1-year CD but I hate the fact that I have to send them a CD maturity instruction and lose days of interests with the check they send me…
i-bonds start to look good from here.
Limit kills the deal. 🙁 Easy to get 6% with a reward checking account, but the limits on those accounts are such a pain too.
Thanks for the post!
Please do let us know how much you decide to lock up…..I’m debating that too!
man what is with the difficulty in setting up a new bank account, mail everything in and it has to be notarized???
Would it really be a good idea to buy the I bonds on April 30th, versus waiting till May 31st for someone only planning on holding the bonds for 11 months + 1 day? If we buy the bond on April 30th, we do lock the fixed rate at 1.2% but we also lock into the variable rate at 3.08% for the first 6 months… A bond purchased in May however, will have an unknown fixed rate but it will immediately earn and compound at least 4.86% in the first 6 months… Even if the fixed rate portion becomes 0%, the yield will still be higher in the first 6 months that the same bond purchase in April will experience.
The “risky” part of the equation is that there are two unknowns if we waiting to buy the bonds in May. IE we don’t know the fixed rate will be, but we also don’t know the variable rate will be in the second six month period. Purchasing the bond in April, you know exactly what your yield will be over the 11 month and 1 day holding period.
But would the gamble be worth it? The I bond fixed rate has been hovering around 1% for the last 5 years. What are the odds the new fixed rate will be significantly lower than 1%?
Secondly, the risk of the variable rate plummeting in the second 6 month holding period is mitigated by the fact that if you sell the bond early you give up the “last” 3 months of interest. So those buying a bond in April of this year to sell in April of next year would earn 6 months at the 4.28% rate, earn three months at 6.06% and then 0% for the last 3 months (due to the penalty).
Assuming the fixed rate will be 1.0% in May, if you wait to buy the bond on May 31st to sell them next year, you will get to keep the full 6 months of interest at the 5.86% rate. If the variable component falls in the second 6 month period the “penalty” you pay will be at the lower rate.
Here’s some examples I put together to demonstrate the effect.
Let’s say someone want to buy a 1000 I bond and has no interest in holding it more than the 11 months and 1 day.
If purchased on April 30 2008, this bond will be worth $1036.87 on April 1st 2009. ($1000 + $21.40 first semi-annual interest + $30.95 second semi-annual interest – $15.47 penalty).
Now, lets look at some scenarios if we wait till May 31st to buy the same bond.
Let’s assume the fixed rate becomes 1% and the variable rate in the second 6 months falls back to 3.08 (IE the same rate the april bond will pay in the first 6 months). This bond will be worth $1039.80 on May 1st, 2009. (1000+29.30+21.00-10.50). The bond will have earned less due to a drop in the fixed rate, but the penalty is significantly less.
With a fixed rate of 1% for a May bond.. The variable rate for the second 6 months would have to fall below 1.94% before the April bond yields more than the May bond.
Partial – That’s also a good idea. I was just thinking it was such a waste that the 3-month penalty kills half the 6.06% part.
Artie – Some good thoughts as well, combining with what partial said. I would guess a fixed rate of under 1%, especially due to the high variable part and the likely demand, as that seems to be the trend. So for a long-term view, buying now seems better. But if you think inflation will persist and you are definitely in it for the short haul, then buying in May may be the better choice.
Buying I Bonds are like using an existing bank for me, so in the hassle department it’s easier than opening up new accounts. It is a pain now to add new linked account though.
One thing to note is that you can buy the bonds with a credit card that earns frequent-flyer miles. (I believe you have to buy in $1000 increments.) So if you buy $5000 in bonds with your credit card, which you pay off immediately, obviously, you get 5000 frequent flyer miles for a “purchase” that earns you money. A sweet deal!
Very useful post. Thanks for sharing this info. How to lookup the fixed rate of I series saving bonds that one is already holding in the treasuryDirect account. I couldn’t find a direct method of finding this information.
I don’t understand how you get 6% out of I-bonds. I just redeemed three of mine last month, and at best they paid out 2.7%, hardly anything close the calculations you’ve provided.
I personally use I bonds as a way to diversify my college savings along with my aggressive 529 accounts especially since the interest is tax-free when using them for education. I may have to give the I bonds a second look while I wait for my T-Bill ladder to come apart.
Is anyone else as annoyed as I am about the stupid new security stuff on TreasuryDirect? If my bank account changes I think I will probably just close my account instead of deal with the hassle. The “Little Orphan Annie” secret decoder ring that they send you to log onto the account must bring bank fond memories to 90 year old account holders but to the rest of us it’s just an annoyance. If someone was going to hack an account, I think the last place they would try to hack would be the United States Treasury.
Buy silver, buy gold. Don’t waste money on more paper.
http://www.financialsense.com/Experts/2008/Williams.html
Martha – where can you buy with a credit card? TreasuryDirect no longer accepts them for electronic bonds (as of several years ago), and paper bonds bought at a bank need to be funded with bank funds also AFAIK.
TL – I bond rates change every 6 months, and the fixed rate portion is determined for the life of the bond at the date of purchase. These calculations are for new I bonds purchased between now and the end of April
I’m opening a TreasuryDirect account now, and it’s like trying to get into Fort Knox! Access Cards, Account Authorization forms, identity certification. I’m surprised they haven’t done the old deposit verification… yet.
In response to other people’s questions, according to TreasuryDirect they no longer accept credit cards as payment.
Unless you plan on spending the money you put into a bond (inflation-protected or not) within the next couple of years, I would reconsider putting serious money into a dollar-denominated asset. I prefer using gold as an inflation hedge and long term govt bonds only as a deflation hedge. Neither of which should be viewed as an investment.
My family lived through the hyperinflation of Germany in the 1920s and the currency collapse. The lesson we learned about real world financial safety was simple: be an owner with your capital.
Does anybody know when the interest date is set for paper I bonds? I got the form from Bank of America today, and upon closer inspection it says: 1) your bonds will be MAILED to you; and 2) may take up to THREE WEEKS to process.
If I was sure that the interest date was set on the date of purchase, I’d be okie-dokie with that.
And…I am waiting for the secret decoder ring from the Treasury. Which considering it’s a week and a half from May 1, I might miss the window of opportunity. Sigh.
How does putting 20k into bonds affect your investment pie chart. Seems too safe to me for someone in their 20’s.
I keep a certain amount of cash separate from my “investment portfolio”, and this money is for my emergency fund. It’s not 100% liquid right away, but it’s only a piece of it.
The updated rates as of May 1 are as follows:
Fixed Rate: 0.00%
Inflation Rate: 2.42%
http://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
FYI, the fixed rate portion of Savings Bonds purchased between May and October 2008 is now 0.00%…ZERO!