Series I Bonds Fixed Rate to 0.50%, Composite Rate to 2.83%; The Role of Savings Bonds In Your Portfolio

by BrokenFireEscape

November 1, 2018 – Series I Bonds purchased in the next six months have a fixed rate of 0.50% and a composite rate of 2.83%

As the Federal Reserve continues to raise federal lending rates, it is fairly safe to assume that the fixed rate on Series I bonds will continue to climb, too. While the fixed rate today is nowhere near historical highs (www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm), we can see that fixed rates are trending up. The fixed rate is now the highest it has been since November 1, 2008.

Background

Series I bonds are U.S government-backed savings bonds that are considered to be one of the safest financial vehicles available for consumers. The reason behind this is two-fold: (1) the bonds cannot lose their value (i.e., their purchase price, plus any interest already gained), and (2) being backed by the federal government means you are guaranteed to the redemption price of the bond, unless the federal government fails (highly unlikely). The interest rate of these bonds is the combination of two components: a fixed rate, that is set for the 30-year life of the bond, and a variable component that is adjusted to inflation every six months (changes on May 1 and November 1). Although the variable and fixed components are announced in May/November, the current variable rate applies for six months following the purchase date of the bond (e.g., buying a bond in January means your rates change in July and January). See the above link for a table that goes a bit more in depth. The composite rate is the combination of the fixed rate and variable rate. A sample calculation can be found by following the link above, but the equation is this: Composite rate = [fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)]. The composite rate is adjusted every six months as well (since the variable rate is adjusted) and is the interest rate that the bond is actually earning. The composite rate also can never go negative. If deflation occurs, and the composite rate equation spits out a negative number, the composite rate will be set at 0.0%. This is what I alluded to earlier (Series I bonds can never decrease in value).

Buying/Selling

There are two methods to buy these bonds. The primary method involves setting up an account on TreasuryDirect and purchasing them electronically with a bank account. Each person is limited to purchasing $10,000 of Series I bonds annually with this method. The second method is using your tax refund to buy paper bonds. Each person is limited to buying $5,000 of Series I bonds annually with this method. The limits on these two methods are separate, meaning you are able to purchase $15,000 of Series I bonds annually. You cannot buy these bonds in a regular brokerage account. This link has more details:(www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm). There are some restrictions on selling the bonds. A bond cannot be sold until it’s been held for at least one year after purchase. Until five years after the purchase date has elapsed, you will lose three months of interest upon selling the bond. The current price displayed in TreasuryDirect should exclude the last three months of interest to reflect this. After 30 years, the bond has “matured” and will no longer earn interest; at this point, you should strongly consider selling the bond since it is no longer increasing in value. Interest on the bonds are taxable at the federal level, but not at the state or local level. The exemption to this rule is if the interest is going towards funding education (www.treasurydirect.gov/indiv/planning/plan_education.htm). You are free to pay taxes on interest annually (as the bonds are accumulating interest) or delay paying taxes until redemption of the bond occurs.

Pros/Cons of Series I Bonds

Pros:

  • Inflation-adjusted return plus fixed rate means, at a minimum, are matching inflation
  • Cannot decrease in value
  • Are extremely safe (U.S government-backed)
  • Funds transferred from sale of bond to bank account within a few days
  • In high-interest environments, you lock in a great fixed rate (e.g., 3.60% in 2000, composite rate for these is ~6% currently) for up to 30 years
  • Beats interest rate of even “high-interest” banks
  • TreasuryDirect website employs two-factor authentication for added security

Cons:

  • Many find the TreasuryDirect website to be not user-friendly
  • If theft of bonds occurs in TreasuryDirect account, there are no guidelines helping you to retrieve lost funds (there are guidelines for paper bonds, however)
  • Equities, especially in low-interest environments, will likely beat Series I bonds over the long-term
  • Have to lock up funds for one year, forfeit three months of interest if sold before five-year mark

So where do these bonds fit into my portfolio?

I don’t have cookie cutter advice on purchasing Series I bonds. Many people feel they are worthless in a low-interest environment like today. However, as interest rates rise, I see these savings bonds becoming more useful and popular. One popular use is using Series I bonds as a vehicle for an emergency fund. There is a great post and subsequent discussion on this: www.reddit.com/r/personalfinance/comments/78uroy/okay_reddit_lets_talk_about_using_series_i_bonds/. One thing I’ll note is that it is strongly recommended to have access to additional funds that can temporarily supplement your emergency fund if you go this route. It is a good idea to slowly buy Series I bonds due to the one-year hold. If you throw your entire emergency fund into Series I bonds and three months later you have a need to access those funds, you’re out of luck. Another use is for savings goals that are at least one year away but have an otherwise unknown timeline (e.g., buying a house). I’m guessing many people who are saving for a house down payment within five years (or perhaps longer) are not willing to risk losing a portion of their savings in the stock market or some other relatively risky investment. Many people will instead just hold this money in a savings account. Series I bonds will likely come out ahead compared to a savings account with little to no added risk. Perhaps you are moderately or highly risk-averse and are trying to save for a longer-term goal. Series I bonds may be a good idea; however, this will depend on your risk tolerance. If you have children and would like to pay for their college tuition, this may be a suitable vehicle. A 529 plan will likely yield better long-term results, but if you have a low risk tolerance, that may not be your cup of tea. Plus, if funds from a 529 plan are withdrawn and used for something other than education expense (in the event your children do not go to college), there may be fees involved.

Closing Thoughts

  • There are also Series EE Savings Bonds; personally, I feel that either Series I bonds or equities would be a superior choice (depending on your needs, risk tolerance, etc.), at least at this point in time. However, I honestly am not very familiar with Series EE bonds.
  • With rising interest rates, perhaps some feel they should wait since the fixed interest rate may be high in six months. Keep in mind that you can sell Series I bonds after a year and reinvest in new bonds at the (presumably) higher fixed rate.
  • Consider buying Series I bonds near the end of the month and selling them near the beginning of the month. The interest is compounded monthly, and you receive the entire month’s interest regardless of the buy or sell date.
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