On Tuesday, the labor department announced the latest CPI-U numbers. With these numbers, you can calculate the upcoming inflation portion of I bonds and determine whether it’s better to buy your bonds now or wait until May. As you may know, I bonds are composed of an inflation rate and a fixed rate. The fixed rate is expected to be zero again but the inflation rate actually went down from 1.76% to 1.18%. According to the labor department, the decrease is due mainly to a decrease in gas prices(I didn’t even notice!).
Buy Your I bonds Now
Even though the rate will be decreasing to 1.18% on May 1st, you can lock in the 1.76% rate for 6 months by purchasing before the end of this month(April). You would receive the higher rate for 6 months until October 2013 when you would receive the new 1.18% rate for 6 months giving you a net yearly return of 1.47%. Even though that may not seem like a lot, it’s a pretty good return for a risk-free investment. Assuming the fixed portion will be 0%, your I bond interest rate would change every 6 months according to the CPI-U.
I bonds increase in value on the first day of the month so you can actually buy your I bonds on the last day of the month and get a full month’s interest. Alternatively, when you redeem your I bonds, you want to redeem them early in the month in order to get a free month’s worth of interest.
Better Than a CD?
I own $6,000 worth of I bonds(5k purchased in 2012, 1k received as a gift in 2013) but I don’t include them in my overall retirement allocation. Since I have plenty of tax advantaged space for my bonds, I don’t feel the need to invest in bonds in after-tax accounts. Instead, I use them more like a CD or fixed rate investment. So how do they compare to the best CD rates?
Ally 1 year CD’s are currently(4/17/2013) paying 0.90% but remember you should always invest in their 5 year CD’s since there’s only a 2 month interest penalty. Ally’s 5 year CD’s are currently paying 1.54%, so if we were to invest in a 5 year CD with Ally and redeem it after one year our effective rate after the 2 month interest penalty would be 1.28%.
You should always purchase an I bond towards the end of the month but I would give yourself at least a 2-3 day cushion to make sure you get your order in on time. Assuming we buy our I bonds on Monday April 29th, 2013 that would give us an interest rate of 1.76% from April to September and a 1.18% rate from October to March. But since we can buy at the end of April and sell at the beginning of March we only need to hold the I bond for just over 10 months to get a full years worth of interest. Our net annual return after the 3 months interest penalty would be 1.40% which is a bit better than the return on a CD.
There is a mandatory 1 year holding period on I bonds so if there’s any chance you might need the money, you should probably go with an Ally CD. I like I bonds though since they’re tied to the inflation rate, which minimizes the interest rate risk and they are exempt from state and local taxes.
Readers, have you bought any I bonds this year? Does it make sense to buy now or would you wait and hope that interest rates go up in September/October?
-Harry @ PF Pro