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Howls of protest started the moment the Treasury did its twice-annual reset of the interest rate on I Savings Bonds. It dropped the annual rate from 6.73% for the November-April period to a mere 2.41% for the May-October period.
The basis for the new rate was a 1.4% annual return that would be fixed for the life of the bond, plus a 1% annualized inflation rate for the May-October earnings period. In each future period the rate would be the combination of 1.4% plus the trailing inflation rate.
One reader who has bought I Savings Bonds since their inception in 1998, wrote to me, "If it is the intent of the Treasury Department to get out of the I-bond business, they have certainly chosen a quick way to do it. I can't foresee anyone purchasing new I-bonds, and I foresee an increase in redemption."
Most people were more like another reader -- mystified by the size of the change and skeptical about the incredibly low inflation rate (scroll down for the semiannual inflation rate) used for the period.
In fact, I believe I Savings Bonds are a better buy today, at 2.41%, than they were when they were 6.73%. With a little patience, the I-bonds you buy today will bring bigger rewards tomorrow.
Do the math
You can understand why by considering how the yield on these bonds is set. I Savings Bonds provide a yield that is based on a rate which is fixed for the life of the bond, plus the inflation rate for the preceding six months.The inflation rate used is the CPI-U, the Consumer Price Index for all urban consumers tracked by the Bureau of Labor Statistics. The CPI-U is the overall rate of inflation, including energy and food.
The CPI-U rate used for the recent reset covering the period from last September through February. When the rate is reset once again in November, it will use the CPI-U inflation rate for the period beginning March through August of this year. Simple, it is not.
Inflation enters in
When the rate was reset last November, the CPI-U inflation rate covered March through August 2005. That's when gasoline prices soared and the inflation rate for the six-month period was 2.85%. Double that and you get a 5.7% inflation rate. Add the 1% fixed rate and you get a 6.7% yield. (The actual yield was slightly higher, 6.73%, due to a compounding adjustment.)When the rate was reset this month, the CPI-U inflation rate for October 2005 through March 2006 was only 1%, much of it due to the temporary decline in gasoline prices. The adjustment for purchasing power over the 12-month period comes very close to the 3.4% rate reported by the Bureau of Labor Statistics, (1.0285 x 1.005 = 1.0336, which rounds to 1.034). So I Savings Bond holders are getting their proper inflation adjustment -- but it isn't delivered in equal portions because inflation rates vary.
The more-important fact here is the fixed rate -- the "real" return over the inflation rate. The 1.4% for bonds sold in the next six months is the best rate offered since late 2002, when the rate was 1.6%. If you believe inflation will be 3% or more in the future, I Savings Bonds are very competitive with both conventional Treasury securities and tax-deferred annuity products.
| Series I Bond Issue Dates | Fixed Rate |
|---|---|
May 2006-October 2006 | 1.40% |
November 2005-April 2006 | 1 |
May 2005-October 2005 | 1.2 |
November 2004-April 2005 | 1 |
May 2004 -October 2004 | 1 |
November 2003-April 2004 | 1.1 |
May 2003 -October 2003 | 1.1 |
November 2002-April 2003 | 1.6 |
May 2002 -October 2002 | 2 |
November 2001-April 2002 | 2 |
May 2001-October 2001 | 3 |
November 2000-April 2001 | 3.4 |
May 2000 -October 2000 | 3.6 |
November 1999-April 2000 | 3.4 |
May 1999 -October 1999 | 3.3 |
November 1998-April 1999 | 3.3 |
September 1998-October 1998 | 3.4 |
Source: Bureau of the PublicDept.: I Bond interest rates
Here's why. I Savings Bonds can be purchased in amounts as small as $50 and can be redeemed anytime after 12 months. The maximum penalty for redemption before five years is the last three months of interest. While you hold the bonds, the interest they earn accumulates tax-deferred until the bond is redeemed. You can hold them as long as 30 years.
Few CD-like annuities offer the flexibility of purchase, low early-redemption costs or the likely yield of I Savings Bonds. Treasury Inflation Protected Securities (TIPS), offer a higher premium over the inflation rate (2.27% for a five-year note, 2.46% for a 20-year note), but the income is not tax-deferred and their market value will fluctuate with interest rates.
Bottom line: While the yield on I Savings Bonds over the next six months will be below what investors have come to expect, they are still a good bet for investors seeking safety, flexibility and inflation protection.
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