The Case For I-Bonds

Sometimes it pays to procrastinate. People who never got around to buying Series I inflation-adjusted savings bonds last winter may have thought they missed a great opportunity when the interest rate plunged from 6.73% to 2.41% on May 1st.

But not so, according to Daniel Pederson, author of Savings Bonds: When to Hold, When to Fold and Everything-In-Between.

The interest rate for I-bonds has two components: a fixed rate that lasts for the 30-year life of the bond plus an inflation adjustment that changes semi-annually, in May and November. Bondholders earned 6.73% for the six months between November, 2005 and May 1, 2006, but the bulk of that was due to the inflation component, which jumped because of last summer's run-up in oil prices. The fixed rate was just 1%.

Although the inflation factor for new bonds has plunged to 1.01%, the fixed-rate component has jumped to 1.4%. So the purchaser of an I-bond is guaranteed 0.4 percentage point more over the life of the bond.

For the past 25 years, inflation has averaged 2.7% annually - which, added to a fixed component of 1.4%, would be equivalent to a 4.1% return on I-bonds. Series EE bonds, currently paying a fixed rate of 3.7%, would be a better deal only if you expected inflation to be lower than average.

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