Chump Change Report: Will I Bonds Pay 6 Percent?
Series I Savings Bonds are indexed to inflation, and pay rates that are adjusted every six months. They don't trade on the open market, and unlike open market bonds, they don't lose value when interest rates go up. They're good for small savers because you can buy them in increments as small as $50, and you can have the purchases auto-debited from bank accounts if you like.
And if the consensus is right about Friday's Consumer Price Index (CPI) report, brand new I Bonds are likely to start paying at least 6 percent come November 1, when rates are adjusted. Without getting into the boring explanation of how I Bond rates are adjusted by Treasury, we'll say that there are two wildcards going into the November rate adjustment: the fixed component and the inflation component.
Treasury may just lower the current 1.2% fixed component to 1%, so it won't have to pay small savers so much interest to finance the gargantuan Bush/Frist/Hastert deficits, but even if Treasury does that, if the inflation forecast comes through, buyers of new I Bonds will still probably earn a 6% compound interest rate for the next six months. Otherwise, 6.23% is the new rate.
Of course if the top-line CPI isn't so bad as we are all thinking it is while we buy groceries and fill gas tanks, the rate could be a bit lower. For example, if the semi-annual inflation rate turns out to be 2.3% instead of the expected 2.5%, the I Bond buyer will only earn 5.8%. But guess what? That's a hell of a lot more than the big shots (and the Chinese central bank) are earning on Ten-year Treasury Notes. And it's also a lot more than the S&P 500 stock index has earned so far this year.
The really good news will probably be for holders of I Bonds that were purchased when the fixed component, which lasts for the life of the I Bond, was higher, say 2%, 3% or even 3.6%. Those Savings Bond holders may find themselves earning as much as 8.6% on their homely old I Bonds, at least for the next six months.
The bad news is, of course, that this is all driven by inflation, the erosion of our purchasing power. There are also some serious concerns about how the Labor Deparment computes the Consumer Price Index, concerns that DOL underestimates the actual impact of inflationary pressures upon Americans.
I Bonds may not be for everybody, but they have done me no wrong. Unlike the other assets in my portfolio, there has not been a single investment period in which both the nominal and "real" (as conventionally measured: as against CPI) values of my I Bond holdings have not gone up.
More information about how I Bonds work (minimum holding periods, rate calibrations, investment minimums and maximums) is at Treasury Direct.
The Consumer Price Index for September 2005 will be announced Friday. If it is 0.9% over August, we will have a semi-annual inflation rate of 2.5%. Treasury will announce the new fixed and composite rates for I Bonds on November 1. We'll be back on this subject then.