Good question on I Bonds today from reader Dan:
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?
Dan, one of the big advantages of an I Bond is that you can sell out after one year (with a three-month interest penalty) and after 5 years with no penalty, but you can also continue to hold that I Bond for 30 years. That is a great deal of flexibility. After one year, you can re-evaluate the market and make a choice.
I view the current I Bond with a base rate of 0% as a short-term investment, possibly one year and possibly longer if TIPS continue running at zero to negative base interest, before inflation.
(Traditionally TIPS have paid up to a 1 percentage-point premium over I Bonds because I Bonds have the advantage of tax-deferred interest and better deflation protection. That premium has now been reversed – TIPS under 10 years now carry a negative base rate – giving I Bonds a clear advantage.)
If, in a year, I Bonds were paying a base rate of interest of 1% versus the 0% today, it would be a no-brainer to sell the current I Bond and buy the new one. You would want to lock in that 1% interest rate premium, possibly for 30 years.
But interest rates would have to change drastically for I Bonds to pay 1%. A more likely scenario would be that I Bonds continue to pay a zero base rate but a 10-year TIPS base rate rises to 1%. In that case, you’d have an interesting choice.
Another possibility is that inflation would turn to deflation. In that case, a year from now, the current I Bond might be paying zero total interest – zero base plus zero inflation. (This happened from May to October 2009 when the six-month inflation rate was running at -2.78%, but the I Bond base rate was then 0.1%)
If that happened again, you might consider selling the I Bond and buying another investment (possibly a bank CD) with some positive interest. Or you could ride out the six months with no interest.
Here is a chart from ForBestAdvice.com that shows how the base and inflation-adjusted interest rates have changed for I Bonds:
|Period||6- Month Semiannual
|Base Rate||6- month
|November 1, 2011 – April 30, 2012||+1.53%
|May 1, 2011 – October 31, 2011|| +2.30%
|November 1, 2010 – April 30, 2011||+0.37%
|May 1, 2010 – October 31, 2010|| +1.54%
|November 1, 2009 – April 30, 2010
|May 1, 2009 – October 31, 2009|| -2.78%
|November 3, 2008 – April 30, 2009|| +2.46%
|May 1, 2008 – October 31, 2008|| +2.42%
|November 1, 2007 – April 30, 2008||+1.53%||1.20%||4.28%|
People who bought I Bonds up to April 2009 certainly made out very well, even with six months of no interest from May to October 2009. In the periods before and after, they got an excellent return.
If you sell your I bond within 5 years you lose 3 months interest. But if the base rate of your I bond is 0%, then technically you lose nothing. Correct?
Not quite. The I Bond pays a combo interest rate – the base rate, which is currently 0% – and the inflation-adjusted interest rate, which is currently 3.06% (annual rate) for six months. So potentially, a three-month interest penalty could be about 0.765%, or three months interest from 3.06%. (But the penalty will come from the interest rate for the next six months, and we don’t yet know what that will be.)
Here’s what we do know:
If you buy the I Bond today, you are guaranteed 1.53% for one year, even if you sell one year from now and even if you pay a three-month interest penalty. You will probably earn more.
That is the worst case scenario, assuming the inflation-adjusted rate falls to 0% in the next adjustment.
Six months at 3.06%, plus six months at 0%, minus three months at 0% = 1.53% annual rate.
OK, I see. Thanks for such a thorough answer. So your point, obviously, is that the i-bond provides this added dimension of choice after a year. And I love this possibility of having a bond with a high base rate that you just hang on to in times like we are in now. It’s kind of surprising to me that the base rate is good for 30 years. That’s a great feature when it works in your favor!
Thanks for all the info on this site!