Excellent timing on a question today from reader Slizzle:
With TIPS yields getting more and more negative, the rates on I-bonds are looking more and more superior every day (since they do not drop below zero). Is anyone else speculating that the government might change their I-bond policy because of this? I could speculate on some possibilities: 1) Paper bonds will not be offered in 2012; perhaps they won’t raise the $5,000 purchase cap on electronic bonds, 2) Perhaps they will allow the fixed rate to go negative like TIPS, 3) perhaps they will change the CPI to make inflation look smaller, and 4) perhaps they will phase out I-bonds altogether. I’m not one for conspiracy theories but it seems I-bonds yields are way above market at this point, and something has to give doesn’t it?
I have already purchased $10,000 of I-bonds for myself this year but I could still purchase another $10,000 in my spouse’s name. I was going to hold off until next year for the convenience of having them all in one TreasuryDirect account, but the huge drop in TIPS yields makes me wonder if it might be smart to buy these sooner rather than later. Thoughts?
I must mention that I am a lowly journalist and not a financial expert, and I don’t even play a financial adviser on TV. Given that, my response:
Slizzle, the government is way ahead of you, unfortunately. The Treasury announced earlier this year that it won’t issue paper I Bonds after Dec. 31, and there is no indication that it will budge the $5,000 electronic limit up an inch. So our buying power in I Bonds falls by half after Jan. 1. That news was rather nasty for savers, but you can understand why the government found this attractive: TIPS real yields are dropping into negative way up the yield curve.
And yes, at any time the Treasury could change the I Bond rules. Different CPI? Could be in the works. Eliminate I Bonds? Possibly. But drop the rate base below zero? That I doubt, since it might involve adjusting the amount you pay up front, like a TIPS transaction. Too complicated for a Savings Bond.
So, you get the BEST ADVICE OF THE MONTH: Buy those paper I Bonds right now. If you buy before Oct. 31, you will be guaranteed an interest rate of 4.6% for six months, and you will be required to hold the I Bond for a year.
After those six months, the inflation-adjusted rate could well be near zero (but not below zero), so you are guaranteed a return of 2.3% over the next year.
If you sell after a year, you would face a 3 month interest rate penalty, but 3×0 = 0. There would be no penalty or it will likely be minimal.
Buying I Bonds up to the limit, right now, is an absolute no-brainer. The best one-year bank CD on the market right now pays 1.19%. I Bonds will nearly double that, guaranteed.
If you wait after Oct. 31, your interest rate could well be zero for the first six months, and that means after Oct. 31, I Bonds will go back on the shelf as an interesting investment no one will buy. (The variable rate was 0.74% before the May 1 adjustment up to 4.6%.)
I Bonds are an unusually attractive option right now. This is easy advice for the super-safe part of your portfolio: Buy I Bonds to the limit before Oct. 31, when that 4.6% rate is going to drop dramatically, possibly to zero. If you buy before Oct. 31, you will get the full six months of 4.6%.
I am not saying you should sell after one year, though. I Bonds purchased now will give you that nice first year, and will match the inflation rate after that, more or less. A 5-year TIPS, which will be auctioned next week, could end up with a real yield of negative 0.6%, maybe much worse.
I Bonds are more attractive than TIPS for 1 year and 5 years, and their tax advantages make them more attractive than a low-yielding 10-year TIPS.
Can’t beat that.
Treasury Inflation-Protected Securities 
Of course my wife and I each set up individual Trusts after we saw the 4.6% rate earlier in 2011 and were able to buy $5,000 paper and $5000 electronic through Treasury Direct for each Trust as well as $5000 paper and $5000 electronic for each of our own SSN. So we were able to quickly get $40,000 into play for six months at 4.6% and then another six months at 3.06%. Even after the new 2012 rules go into effect we can still do $5,000 in each individual account and in each Trust account. If you want to invest in I Bonds you should set up a trust if you don’t already have one. The decision to drop the $30K limit to $5K in paper and electronic and now following it with a limit of only $5K electronic is an affront to faithful investors in U.S. paper and should be a campaign issue in 2012.
Thanks for this excellent feedback. I agree that it is a tragedy that the U.S. government won’t allow its citizens to buy more than $5,000 each in Inflation-Protected bonds, even though those bonds guarantee them a zero real return. A zero real return from I Bonds (exactly matching inflation) is hardly a gift, but it is the best short-term, super-safe investment available as 2011 closes.
So the Chinese can buy many $billions of dollars of U.S. debt, but an individual American can purchase only $5,000 per year of our debt. WTF?
Thad, I have read that too, and I know some people are trying to overpay withholding or estimated taxes to get the benefit of buying paper I Bonds above the limit. Well, why not? If enough people do this, maybe the Treasury will realize it would be more sensible to lift the limit on the Treasury Direct purchase of I Bonds. I’d say put it at $30,000 per Social Security number, or maybe even $50,000. That would be attractive to regular investors, but way too small for big-money investors to bother with.
If you read the Treasury announcement at the bottom, OVER THE COUNTER (bank) sales of paper i bonds are halting, but you can still use your tax refund to buy paper bonds, so that would be the only way to get to $10k electronic+paper. I didnt find any explicit change in the caps for 2012. However, stuffing an extra $5k in payroll taxes certainly remains the challenge in doing it that way…
“Series I paper savings bonds remain available for purchase using part or all of one’s tax refund. For more information on this feature, visit http://www.irs.gov.”
Understood. Thanks —
The fixed rate has been 0% since Nov. 1, 2010, and it was 0.2% before that. With Treasury rates at record lows, and even 10-year TIPS currently offering negative real yields, if I Bonds could be negative, they would be. But they can’t go below zero, they can only be zero.
So it’s likely the rate will be zero.
Right. But on the flip side, the fixed rate is also adjusted on Nov 1. So that 0% may either stay the same or go up. If it goes up more than enough to offset the decline in the 4.6%, it’s better to wait to purchase . . . right? Plus the fixed rate extends for the life of the bond, not just the next 6 months.
I see what you are saying, and I agree that the inflation-adj rate will fall . . . but how can one be sure that the fixed rate won’t spike up?
The interest rate you get with an I Bond is a combination of two factors: 1) the fixed rate, which as of May 2011 is 0%, and 2) the Inflation-adjusted interest rate, which in May 2011 was set at 4.6% for six months, for an effective rate of 2.3% annually.
Yes, the base rate is 0%, and you can compare that with a 5-year TIPS, which will be auctioned next week with a base rate that will end up somewhere between negative 0.6% and negative 1.0%. Zero is better than negative, and that is the I Bond’s advantage.
The inflation-adjusted interest rate for I Bonds changes every six months, and so it can fluctuate. That May rate of 4.6% was propped up by soaring energy prices, and that will end up being reversed when the rate is re-set in October. There is no doubt that official inflation is running well under 4.6% right now. In fact, the inflation rate for May to October might be essentially zero, or close to it, because energy prices are going down fast.
Great insight as usual. The TreasuryDirect site is a bit confusing though, as they list the May 2011 rate as 0% here (under the “Fixed Rates” section): http://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
What am I missing?