Last pitch for buying I Bonds in 2011

The Treasury will auction a 5-year TIPS on Dec. 15, probably a reissue of CUSIP 912828QD5 that currently carries a yield-to-maturity of -0.980%. Yes, that is a negative, and it means buyers of this TIPS are willing to accept a rate of return nearly 1% lower than the rate of inflation for the next five years.

Why would they do that?

1) This TIPS is a super-safe investment, 2) world markets are still in turmoil and super-safe investments look attractive, 3) the Federal Reserve won’t budge on raising interest rates anytime soon, and 4) there aren’t many super-safe alternatives.

  • A 5-year nominal Treasury is paying 0.92%. That means the TIPS buyer needs inflation to run at 1.9% or more over the next 5 years to win over a nominal Treasury. Not a bad bet, plus the buyer gets protection from higher inflation.
  • The best 5-year CD is paying 1.84% (Ally Bank, as of Friday). That one actually competes pretty well with the 5-year TIPS, pushing the break-even inflation rate up to 2.82%. Before you buy that 5-year TIPS, look hard at this CD. But you would give up protection against higher-than-expected inflation.
  • On the other hand, the average 5-year bank CD is paying 1.17%, not very attractive versus the TIPS.

I Bonds, still the better investment. If you didn’t buy I Bonds before the Oct. 31 interest-rate change, go ahead, kick yourself. The six-month rate fell from 4.6% to 3.06% for the six months ending in April 2012. (Buyers get the current rate for six months after the purchase, so you could have guaranteed yourself a 2.3% 1-year return, or better.)

I Bond Nov. to April 2012Forget that 4.6% rate. If you haven’t bought I Bonds in 2011, you should still ponder this investment before Dec. 31. Here’s why: The Treasury puts yearly limits on I Bond purchases. You can buy $5,000 in Treasury Direct and $5,000 in paper bonds each year. A couple can buy twice that. Paper bonds will no longer be issued after Dec. 31, except as a tax refund.

So you could still load up on this I Bond in 2011 (paper and electronic) and then again in 2012 (just Treasury Direct purchases and your tax refund).

I Bonds currently carry a base interest rate of 0%, plus an inflation-matching interest rate that changes every six months. That makes them much more attractive than a 5-year TIPs with a return that is is 0.98% below the inflation rate. Zero is good. Negative 0.98 is bad.

The current I Bond interest rate – 3.06% – guarantees that you will receive a 1-year return of 1.53%, but probably higher, even if you sell after one year and pay a three-month interest rate penalty. If you sell after 5 years, there is no penalty.

While you could consider a 5-year CD if you can find an attractive rate, there really is no contest between this I Bond purchase and the 5-year TIPS reissue of Dec. 15. I Bonds are still the clear winner, even at a lower interest rate.

And if you have purchased I Bonds up to the limit in 2011, you can hold that investment for one month and buy them again in January 2012.

About Tipswatch

Author of Tipswatch.com blog, David Enna is a long-time journalist based in Charlotte, N.C. A past winner of two Society of American Business Editors and Writers awards, he has written on real estate and home finance, and was a founding editor of The Charlotte Observer's website.
This entry was posted in I Bond, Investing in TIPS, Savings Bond. Bookmark the permalink.

3 Responses to Last pitch for buying I Bonds in 2011

  1. joe says:

    Looks like with at real 0% rate and tax free accumulation, the i bond beats TIPS by a good long margin at the moment

  2. Dan says:

    From what I read here and elsewhere, that base rate of 0% holds for the full 30 years and the variable part changes each 6 months. Is it ever the case that after a year one would want to cash out the I-bond and repurchase at some higher rate? Say the base rate went up to 1%. Would you sell your 0% i-bond and repurchase? Or does this never pay off to do that?

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