My usual theory on US Savings I Bonds is to buy them up to the limit in January, no further questions needed. But this year I didn’t do that, and I think a lot of I Bond faithful probably joined my on the sidelines.
The question isn’t whether to buy I Bonds in 2014, it is just when.
I like I Bonds because they are an extremely safe, extremely flexible fixed-income investment, earning tax-deferred interest with the added bonus of inflation protection. They cost nothing to buy at TreasuryDirect.gov and have no hidden fees.
The one negative in this perfect world is that you have to wait a year to sell them. And if you sell within five years, you will pay a small penalty of three months’ interest. So:
- I Bonds work for capital preservation. Why do a lot of people with a lot of money buy $20,000 a year in I Bonds and scheme to find ways to get $5,000 in a tax refund as a paper I Bond? They are seeking to build a large stockpile of tax-deferred, inflation-protected money to draw on later in their retired years. I call this ‘punting money into the future.’ Because of the tax deferral, I Bonds work very well for this, and inflation is the arch-enemy of people with adequate nest eggs.
- I Bonds work as a short-term savings account. Let’s say you’ve saved enough money for a house down payment a year or two from now, or for your child’s college education in a couple of years. You are looking to protect that money, while earning some return. I Bonds can meet that need, as long as your target date is one year out.
- What I Bonds don’t do: build wealth. You cannot become wealthy earning 0.2% interest above inflation, investing $10,000 a year. If you are 23 years old and just starting out investing, the better moves are maxxing 401ks and Roth IRAs with investment in low-cost index mutual funds. When you get to the point where you are considering a house savings fund, though, I Bonds might make sense.
What they pay. I Bonds currently combine a fixed-interest rate (0.2% for I Bonds issued through April 30) and an inflation-adjusted interest rate (currently 1.38% through April 30.) That means a total annualized return of 1.58%, but remember that the inflation-adjusted rate will change on May 1. Because inflation has been very low recently, the rate isn’t likely to jump up.
Understanding the fixed rate. That rate stays with the I Bond you purchase through its entire 30-year term. So if you buy I Bonds through April 30, you will get a fixed rate of 0.2% for 30 years. If you bought last year with a fixed rate of 0.0%, your fixed rate will be 0.0% for 30 years. The I Bonds I bought back in 1999 still carry a fixed rate of 3.60%. Here is a history of fixed rates.
So buy now or buy later?
I noted earlier this month that I decided my first investment of 2014 would be the 3% 5-year CD offered by the Pentagon Federal Credit Union, and explained why I saw this as potentially better than an I Bond. PenFed is offering this rate only until Jan. 31, so time was limited.
That’s done, and now comes the decision: Should I buy I Bonds now or wait until May or November 2014, when the fixed rate is subject to change. To wait is to gamble the rate will stay the same or go up. But it could go down, and that’s the risk.
This topic has been passionately debated lately in the Bogleheads forum, but then again all issues get passionate in that forum. I recently posted there:
The I Bond fixed rate is now set at 0.2%, which I consider a ‘gift’ from the US Treasury. There really was no justification for setting the rate above zero. Typically, I Bonds pay about 1% less than a 10-year TIPS. And rightly so, because I bonds earn tax-deferred interest until you cash out, and they offer a flexible maturity schedule, 1 year (with a small penalty) to 5 years (no penalty) to 30 years. Your choice.
With the 10-year TIPS now yielding 0.7%, the conditions still aren’t there for a bump in the I Bond fixed rate, but things could change in 2014. You have until April 30 to decide. If you see the 10-year TIPS rate dropping, it is highly unlikely that the I Bond fixed rate would increase. If you see it rising, let’s say to 1.2% or higher, then hey, wait it out.
FYI, the 10-year TIPS market rate is currently yielding 0.55%, plus inflation, well off the 1.2% I say the Treasury would need to justify raising the I Bond fixed rate. You can check approximate yields here.
So at this point, I don’t see any reason to believe the Treasury will raise that I Bond fixed rate on May 1. Most likely it will stick at 0.2%, but there is always the chance it will return to 0.0%.
Oh, and how about waiting until Nov. 1, when the fixed rate gets adjusted again? There is a possibility that interest rates will rise sharply by November, as the Federal Reserve exits its bond-buying stimulus. Waiting will cost you only 0.2% over 30 years, at the most. But if the fixed rate rises, the waiter would be the winner.
However, that November rate will still be available on Jan. 1, 2015, when you can snap it up with your 2015 purchase limit.
I am not much of a gambler, so I’ll probably buy before April 30.