Tuesday was a big day at the bureau of labor statistics; they released the news that we’ve all been waiting for. The Consumer Price Index for All Urban Consumers(CPI-U) increased 0.6 %! Ok I have no idea what that actually means(ok maybe I do, no one should care though), but I do know how it affects I bond rates. The inflation portion for I bond rates will be going down to a semi-annual rate of 0.878%(composite rate of 1.76%) from 1.1%(composite rate of 2.2%).
A few weeks ago we discussed how I bonds work and I also said that I wanted to wait and see what would happen to the inflation rate before buying. The decreased rate doesn’t surprise me much; I think most people were expecting a slight decrease. But even with the reduced rate, I bonds still make sense for short term savings goals because they are one of the highest yielding ‘safe’ investments. There is a slight chance(~5%) that the fixed portion could go above zero in November, but I wouldn’t bet on it.
I Bonds vs Ally 5 Year CD’s
Ally’s 5 year CD’s are one of the best options for a high yielding safe investment next to certificate of deposit Discover. Unlike bonds, your CD investment is guaranteed by the full faith of the US government(as are I bonds) and your money can stay liquid since Ally carries a minimal 2 months interest penalty. As of 10/12/12, the rate on a 5 year CD at Ally was 1.68%. Although the rate is lower than I bonds, Ally CD’s have only a 2 months interest penalty(as opposed to three months for I bonds) and there is no one year holding period like with I bonds. You can also cancel an Ally CD at any time for any reason. So let’s take a look and see if the opportunity cost is still worth it.
If you listen to my advice and buy your I bonds at the end of the month and sell at the beginning of the month, you can effectively get 12 months worth of interest in only 10 months. Let’s assume we buy $10,000 worth of I bonds on Oct. 31st. Since the new rate will take effect Nov. 1st, we can lock in the 2.2% rate for 6 months as long as we buy before this date. For the second 6 months, we’ll receive a 1.76% interest rate.
Timeline:
10/31/12 – Buy $10,000 worth of I bonds
10/31/12 – 3/31/13 – Our I bonds earn 6 months worth of interest at 2.2% in only 5 months
3/31/13 – Our I Bonds are now worth $10,109.40 = { 10,000*(1+0.022)^(6/12) }
4/1/13 – 9/1/13 – Now our I Bonds are only earning 1.76% 🙁
9/1/13 – Our I bonds have gone from $10,109.40 to $10,197.98 = { 10,109.40*(1+0.0176)^(6/12) }
If we decide to take our money out right now, we’ll have to pay 3 months worth of interest($44.38), so you’ll end up with $10,153.59 or an APR of 1.84%. Detailed calculations can be found here. As long as you don’t mind letting your money sit for a year, you should come out ahead by choosing I bonds over CD’s. In fact, Ally’s 1.68% APR is reduced to 1.40% when you take into account the 2 months interest penalty. And remember, there are no state taxes paid on the interest received from I bonds.
I’ll most likely be investing 5k or 10k at the end of the month depending on my cash flow. Although the rate isn’t impressive by any stretch of the imagination, it’s better than anything else I can get right now. After a year, I’ll take a look at where the rates are and assess whether I should redeem my bonds or hold out for some better rates.
Readers, now that you know the I bonds rates for November are you going to buy some this month or is there even a reason to wait until next month? Or do you plan on staying away from I bonds altogether until we see higher rates?
-Harry @ PF Pro
Track All Your Accounts With Personal Capital
Personal Capital lets you see all of your accounts in one convenient place. Sign up now for free.Thanks to reader Bichon Frise for helping out with some of the calculations. And to find out more on how I bonds work, read my article, An Introductory Guide to I Bonds: Do They Make Sense for Young Investors?
I was wondering what your thoughts would be when they made the announcement on Tuesday. I am not certain what we’d do. We’re pretty happy with our MMMF’s. I can’t remember off the top of my head what they’re earning rate wise. I do know it’s better than most out there…but then again, that’s really not saying much!
Yea it seems a little silly arguing over .2, .4% here and there but eventually rates will go up and that’s when things like this will really matter.
I would be very surprised though if your MMMF’s were close to this rate though. Generally CD’s and I bonds are higher these days and you also have to remember that MMMF’s do have some risk(only a couple funds have ever defaulted – Reserve Primary Fund), albeit small.
I really need to look into these as a place for my emergency fund. Maybe buy like $1,000 a month until my refund is fully in I bonds. Something to think about at least.
Yes that’s definitely a good idea, but remember you have to hold the money for at least one year. So let’s say you have a 20k emergency fund, you could ladder it in 5k increments so that you never have more than 5k unavailable(pulled this example from the bogleheads forum)
year 1: buy $5k ibonds, $15k sits in ef
year 2: buy $5k ibonds, $10k sits in ef, $5 in redeemable Ibonds
year 3: buy $5k ibonds, $5k sits in ef, $10k in redeemable Ibonds
year 4: buy $5k ibonds, $0 sits in ef, $15k in redeemable Ibonds
year 5: $20k in redeemable Ibonds
year 6: first set of Ibonds have matured 5-years, have no penalty to redeem
I don’t mean to be a party pooper again, but I think the CPI is worthless. They just take things out if the price goes up too high (like housing), so it really doesn’t even reflect true inflation. I think inflation is actually much higher, and I don’t trust the gov’t to report a truthful number, because the higher the number, the better for you and the worse for them. With our government owing ~$16 trillion, they can’t really afford to be truthful!
I think one of the things that sucks most about artificially low interest rates is that it’s so hard to find a safe investment for your short term needs. The yields on the traditionally safe securities like treasuries, I bonds, TIPS, etc, are so low, as you point out, that it’s barely worth it. For short term investments, I’ll keep cash but mostly hold gold and silver, unless either of those look overbought, of course.
Matt, no worries man. It’s good to have conflicting opinions, if we all agreed, commenting would be no fun. What level do you think inflation is at? I agree with you that inflation probably isn’t at 1.76% right now(that seems low), but I don’t think it’s out of control by any means.
Either way though, these I bond rates are higher than any other guaranteed investment you can get right now, right? If you’re worried about the 1 year holding period, I understand that, but other than that, I don’t see a reason why not to put your money in the highest yielding safe investment available.
I’m not trained well enough to guess what inflation is right now, but from reading the works of people I trust, like Peter Schiff, Jim Rogers, etc., I think it’s probably at 7%, 8%, but who knows. You can’t have interest rates at 0, print at least $40 billion every month, and expect inflation to be under 2%. It just doesn’t make any sense. Because of all the manipulation of interest rates and the money supply, it’s tough to know the exact rate.
I just don’t see these bonds as safe. If interest rates tick up even a little bit, the US is screwed, and no one will be willing to lend to the gov’t. That would make your bonds worthless. The gov’t used to finance its debt with 30 year paper: now we do it with 3, 5, and 10 year paper. Our country is essentially on a giant adjustable rate mortgage. If China suddenly decides it wants a higher rate of interest because it’s worried about repayment (which they’re hinting at already), you can kiss your bonds goodbye.
Ok I see your point, but I don’t think that applies to I bonds at all. Although the CPI-U may determine the interest rate on bonds, you are free to redeem them at any time(after one year). Unlike TIPS, if interest rates go up and bonds go down, you can just redeem your I bonds similar to my Ally 5 year CD strategy and decide whether you want to buy more I bonds or something else.
Like you said, if you don’t feel bonds in general are a good investment because of the reasons you mention, you are free to invest in other things. But trust me, I bonds are the safest (and highest yielding among no risk investments) investment out there. Unless you think there is a chance the entire US government will default which I think is very far fetched and will not happen in our lifetime.
I know what you’re saying, but my point is that anything that is redeemable in dollars would be worth much less in that scenario, regardless of when you’re allowed to redeem it. You wouldn’t get the same purchasing power back either way.
People used to say housing was a safe bet. They said an index was safe in 1999, and 1929 for that matter. I don’t consider something safe if the whims of one man can destroy all of the value in my security.
@Chicken Little – Inflation should be rather easy to measure, at least on a personal basis. Take your expenses and see how much your grocery bill has changed in the last year or so. Wash, rinse repeat for any other categories or your entire expenses.
You should also learn the difference between a t-bill, note and bond. As all have been around for many years. While you’re educating yourself, perhaps learning how bonds work would be beneficial as well.
Chicken Little here. See my comment above.
Ha! I used to own each type of those securities back when I was as ignorant as you! Sold em all and bought gold and silver. Feeling pretty good about it. Go ahead and email me I can chat about bonds and Tbills etc. all day.
Go educate yourself on what an interest rate actually is and how an economy actually works.
Also, that really is a good idea, to measure inflation that way. I’m not being sarcastic. That’s exactly why food prices are not calculated in the CPI! You’re proving my point! The government excludes it because it was bringing the CPI up. Food prices used to be in there, but not anymore. They’re too “volatile.” Go educate yourself on what the CPI actually is while you’re at it.
Also, the government subsidizes the hell out of corn and wheat, and they give more and more each year. So, it would be tough to measure inflation that way because again, most of our food prices are manipulated by the government.
Now you’re loosing it Chicken Little. CPI does take into account Food. http://www.bls.gov/cpi/cpifaq.htm In case you’re lost, it’s the question, “What goods and services does the CPI cover?” Food is the top of their list.
The point of measuring your personal inflation is that you claimed, “I’m not trained well enough to guess what inflation is right now…I think it’s probably at 7%, 8%, but who knows.” I left off your name dropping. But, I do measure my personal “inflation”, and it isn’t too far off from what CPI says.
Chicken Little, is your name really Rob Bennett?
I normally don’t make point out typos or misspellings, but since you deserve it, I think you meant “losing.”
Anyway, Core CPI does not include food and energy.
http://www.bls.gov/cpi/cpiqa.htm
You may argue, which I’m sure you will, that I-bonds use CPI-U All items (including food and energy), so that shouldn’t matter. To be honest, I don’t know which CPI-U I-bonds use, and it doesn’t matter. The CPI that the Fed uses to set interest rates is the Core CPI, which excludes food and energy. So, the very entity responsible for the inflation from which you’re attempting to protect yourself does not take into account food and energy. Economic nonsense.
If you want some articles on the history of the calculation of the CPI, which I’m sure you don’t because they’d debunk your theory that we have a responsible, truthful government, then I’d be happy to give them to you.
I’d like to point out that irony of the typo in my first sentence. Oops!
Nice write up!
Of course, there are some underlying assumptions in that 1.84% rate. Like, earning 1.84% for the other 2 months. It is artificial, but useful for an apples to apples comparison.
If there is one lesson about the “rate pinching” we are all doing now, it is to lock up some ibonds for the long term if and when they ever increase the interest rate component of the composite rate.
Yea I agree but it does work well for comparing your options. It’s funny how just 5-6 years ago the fixed rate was 4-5%; people would kill for that rate now.
And it really wasn’t much of a stretch to buy I bonds at the time. It’s definitely not like saying I wish I would have bought apple 5 years ago, buying I bonds was actually a safe investment. If they ever go back up, I’ll be sure to lock in some good rates though.
One thing to remember….when rates do start to climb say 5 years from now wouldn’t you be glad you invested 10K per year and have 50K stashed to take advantage of those higher inflationary rates. When they come back you can only deposit 10K a year so why not build up the kitty…..just a thought
That’s a good point. I never thought about it like that. I guess it also matters how the fixed portion is doing at that point but yes you’re right. If the inflationary rate goes way up, you’ll have a nice nest egg invested instead of only being able to put 10k in a year.
(Although you can put an additional 5k in through tax return, 10k for a wife, 10k for kids, etc. And with the kids, if you set yourself as beneficiary and them as primary, the ‘kids’ won’t have to pay any taxes as long as their interest income is less than the standard deduction ~$800)
Just started with Ibonds a few years ago, and am using them for a future inflation safety net. The Ibonds help diversify and offer peace of mind. Harry, I like your idea for purchasing Ibonds for the kids.
Thanks, one of my readers actually e-mailed me about the purchase limits. So I looked into it further and discovered you could buy them for your kids!
Like I said above, if you set them as the owner and you as the beneficiary, the kids would pay the tax(that’s how I would do it!), which should be nothing.
But if you set yourself as a co-owner you will have to pay the tax even if it’s in their name and they redeem it in 20 years without telling you, haha.
We don’t carry a lot of bonds. Typically only 20% of our portfolio.
Thank for the info though.
I’m not counting these as part of my retirement portfolio. Instead, I’m using them b/c they offer the highest yielding short term(0-5 years) investment.
For me, the state tax on interest easily makes up for the extra month penalty. I’ve used I bonds for years and they’re a good tool for savings.
JP, good point. I didn’t include that in my calculations but it’s definitely something to keep in mind. Could be up to 10% depending on your state and rate.