Updated: May 3, 2013 12:14PM
Originally published: April 26, 2006
Savings bonds rates are about to take a sharp drop. If you buy a Series I bond before Monday, you’ll earn 6.73 percent annual interest for the next six months. But if you buy a Series I bond after May 1, it’s likely that you’ll earn only about 2 percent for the coming six months! (The final determination on the new Series I bond rate will be made by the Treasury department on Monday.)
If you’re looking to lock in high rates -- for a while, at least -- you should rush to your financial institution or go to www.treasurydirect.gov/indiv/indiv.htm and place your order. (Individuals can purchase up to $30,000 of paper I-bonds, and an additional $30,000 of bonds electronically every year.)
That conundrum about falling savings bond rates in a period where other rates are rising all stems from the way rates on Series I savings bonds are calculated.
I-bonds have two components. There’s a fixed base rate for the life of the bond, determined at the time you buy the bond. When I-bonds were first issued in September 1998, the fixed base rate was 3.40 percent. And those bonds will continue to have that base rate for the 30-year life of the bond.
The base rate on bonds purchased after that date, however, was changed every six months and is currently set at 1 percent.
The second part of the interest rate paid on I-bonds is based on a complicated formula that’s not worth reprinting here.
The government looks at its nonseasonally adjusted Consumer Price Index twice during the year -- at the end of September, and again at the end of March. A huge jump in the rate of change in the index led to the new rate of 6.73 percent that was established Nov. 1, 2005. But at the end of March, the index stood at 199.8 -- up only 1 point from the previous 198.8. So, based on the government’s calculation, it appears that the “semiannual inflation factor” will be only 1 percent starting May 1.
Add that 1 percent to the base rate of 1 percent, and it looks like Series I-bonds will pay only about 2 percent starting May 1 and for the following six months.
Of course, if you have older I-bonds with a higher base rate, you’ll get your new 6-month rate by adding the 1 percent inflation factor to your base rate, plus a small fudge factor that recognizes you’ve held those older bonds. The actual rates will be posted at the Treasury Web site.
One more important note: If you buy I-bonds today, at the current 6.73 percent rate, you’ll keep earning that rate for the next six months. Then the rate on your bonds will drop to the expected 2 percent rate for the following six months. In fact, if current rising energy prices contribute to another big jump when rates are re-set on Nov. 1, 2006 -- you’ll still be stuck earning that low 2 percent for the full six months.
You can’t play the interest rate game with these bonds by selling when rates drop. You must hold I-bonds for at least one year before cashing them in. And if you redeem before 5 years, you’ll lose 3 months interest.
Bottom line: Series I-bonds are for long-term holders. Eventually, you’ll get the benefit of all those six-month adjustments and you’ll keep up with inflation. But starting May 1 the Treasury Department is going to have a lot of explaining to do. And that’s The Savage Truth.
Terry Savage is a registered investment adviser.
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