For the next six months, a new inflation-adjusted Savings Bond will provide exactly the same investment return as the space beneath your mattress.
Treasury announced last week that inflation-adjusted Savings Bonds purchased from May through October will earn 0 percent for the first six months they’re held. This is the first time I Bond returns have fallen to zero since Treasury started issuing them in 1998, says Daniel Pederson, author of “Savings Bonds: When to Hold, When to Fold, and Everything In-Between.”
Consider this the downside of $2 gasoline. The I Bond consists of two components: a fixed rate that stays the same for the life of the bond and an inflation rate that’s adjusted every six months. The inflation component for I Bonds issued from May through October is based on the change in the consumer price index from September through March.
Primarily because of sharp declines in the cost of energy, consumer prices fell at an annual rate of 5.56 percent from September 2008 through March 2009. The decline in the inflation rate will vaporize the 0.10 percent fixed rate for I Bonds issued from May through October. The drop will also wipe out the interest on older I Bonds with much higher fixed rates, says Tom Adams, author of Savings Bond Advisor. The 0 percent interest rate will affect “every I Bond that’s ever been issued,” he says.
The only good news is that I Bond owners won’t lose any money. Under the Treasury formula, the earnings rate on I Bonds will never fall below zero. If you already own I Bonds, you won’t earn any money during the relevant six-month period, but you won’t lose any of your principal.
This may come as small consolation to I Bond owners who are facing six months of oblivion. But before you ditch your I Bonds, there are a couple of factors to consider:
- When your inflation-adjusted rate will reset. The inflation component of your I Bond is adjusted every six months, depending on when you purchased your bond. If you own an I Bond that was purchased in April, for example, your rate won’t drop to zero until October, Adams says. Until then, the bond will continue to earn an inflation-adjusted rate of 4.92 percent, plus the fixed rate that was in effect when you purchased your I Bond. Sell now, and you’ll give up five months of above-average interest.
- The fixed rate for your I Bonds. If you purchased an I Bond in 1998 through 2001, you should hold on to it, even during this fallow period, Pederson says. Those bonds carry fixed rates of 3 percent or more for the life of the bond.
When high gas prices led to a surge in the inflation rate last spring, some of these older I Bonds earned more than 8 percent. Even if inflation rises to a modest rate of 2 percent to 3 percent, these bonds will earn 5 percent to 6 percent, Pederson says. But if you sell, you’ll lose that fixed rate forever.
“Don’t do something knee-jerk because you see a 0 percent rate,” Pederson says. “Over the long haul, you could still have a very attractive investment.”
On the other hand, if you own some I Bonds with lower fixed rates, the six-month 0 percent rate offers an opportunity to ditch them without paying a penalty. When you buy an I Bond, you can’t redeem it for a year, and if you sell in less than five years, you’ll forfeit the last three months of interest. But if your interest rate for those last three months is zero, cashing out early won’t cost you anything.
While the recession has kept prices in check, many analysts believe large-scale government borrowing will eventually ignite inflation, which would increase the I Bond’s return. But even if you agree that inflation is a looming threat, it’s probably not a good idea to buy I Bonds now, Pederson says, because of the low fixed rate.
The 0.10 percent fixed rate Treasury is offering for I Bonds purchased in May through October means you’ll earn only a hair above the inflation rate on any I Bond purchased from now through Oct. 31. If you believe I Bonds are a good long-term investment, Pederson says, “There’s no risk to waiting until Nov. 1 and seeing if they do better with the fixed rate.”
In addition to the I Bond, Treasury offers an EE Bond that pays a fixed rate for the life of the bond. Treasury said last week that EE Bonds issued from May through October will pay a rate of 0.7 percent, down from an already measly rate of 1.3 percent for EE Bonds issued from November through April. Even in this low-rate environment, Adams says, “It’s just really hard to come up with an argument for investing in EE Bonds.”
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CONSERVATIVE PAYS LITTLE
I Bonds purchased from May through October will earn a 0 percent interest rate. Yields on other conservative investments:
1-year CD: 1.28 percent
5-year CD: 2.24 percent
Money market account: 1.34 percent
6-month T-bill: 0.30 percent
2-year T-note: 0.94 percent
Sources: Bankrate.com, Bloomberg News