Stephen Willey: ‘I bought a ton of the I-Bonds with my MBNA miles card with no interest till April and just noticed that the new rate is now 4.4%. If I understand correctly, the 5.92% rate that we got for purchases from May 01 to October 31 will fluctuate with the stated inflation adjuster, but the base rate of 3% never changes. Does this mean that the current bonds use a lower base rate and the same inflation adjuster?’

☞ Exactly. The new rate is 2%-plus-inflation down from 3%-plus-inflation. Here’s the link that explains it very clearly.

As a taxpayer, I’m pleased to see the Treasury paying as little interest as possible. As an investor, I’d like to see the highest rate possible.

If these bonds sell briskly, even at this low rate, the Treasury priced them well. If most people stay away, then six months from now the Treasury is likely to set the new rate higher, to attract more buyers. There are no guarantees, but you might want to wait.

Then again, when you think about it, a completely safe tax-deferred bond that insulates you from both inflation and deflation is not the worst way for the little guy to save some money.

(The I-Bonds’ inflation protection is explicit and obvious. The deflation protection is less obvious but no less real. Let’s say we had serious deflation, meaning that things just got cheaper and cheaper. That almost surely will not happen – and ain’t nearly as much fun as it sounds – it’s called a depression – but if it did, stock prices and real estate values would plummet, wages would be cut, and the consumer price index would go down. Yet there you would be with the full value of your I-Bonds, which are guaranteed never to go down. In any six-month period, the worst that could happen is that they would not go up. Which is pretty good, because to keep full value when everything else is getting cheaper is actually to gain value.)

So even 2%-plus-inflation, as pathetic as it sounds, is not nothing, under these circumstances. And it certainly beats losing 60% in some stock. Nor are you locked into the bargain for 30 years, even though Uncle Sam is. You can always redeem your bonds early, although you will be docked a rather mild three months’ interest if you do so within the first five years of purchase. (And, remember that interest accrues from the first day of the month, even if you buy on, say, the 29th day, and that if you put them on a credit card, you may have more than another month to pay for them before racking up any interest charges, so you can actually get much of that first three months’ interest ‘free.’)

What does seem unfair, and may lead to enough of a drop in I-Bonds sales to push up the new rate six months from now, come May 1, is that just a few weeks ago TIPS were issued at auction to yield 3.4%. TIPS, you will recall, are Treasury Inflation-Protected Securities. They work somewhat like I-Bonds, without the tax advantages. They have risen in price a bit since then (unlike I-Bonds, they trade in the open market), and so yield a bit less than they did. But last I checked, they still yielded over 3%.

With I-bonds, the little saver is taking a 100-basis-point haircut – getting 2% on I-Bonds instead of 3% on TIPS – in return for (a) the tax deferral and (b) the ability to buy $100 or $250 worth at a pop, say, rather than $10,000 or $250,000 worth. Not to mention those frequent flier miles you can get buying I-Bonds with a credit card that gives miles. Or the chance to avoid tax on your interest altogether if the bonds are used to pay for college or postgraduate tuition. (To do this, you need to attach form 8815 along with your tax return stating that you used the proceeds of the bonds in the year you cashed them in to pay qualified tuition expenses. You need to have turned 24 before the issue-date of the bonds. And the tuition tax benefit begins to phase out rapidly if your adjusted gross income exceeds about $54,000, filing singly, or $81,000, jointly.)

As usual, the little guy doesn’t get as good a deal as the big guy – just as buying the 4-ounce size rarely gives you as good a value as buying the economy size – not necessarily out of malice, but because it costs more to sell to the little guy.

I think the Dow is too high here and more likely to fall markedly than rise markedly in the short-term. (My opinion in such matters is worth precisely what you are paying for it.) In the short-term, therefore, I might grab my super-safe 2% from Uncle Sam rather than reach for AOL at 87 times earnings (yes, I know Harry Potter opens November 16th, and I can’t wait to see it, either, but still) or the Dow at 9750.

That said, over the long run, stocks should beat inflation by more than 2%. So if you did buy these bonds, the time might come when you chose to cash them in early, pay tax on the interest you had deferred, and buy stocks or index funds instead.


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