U.S. Series I Savings Bonds purchased from November 2018 through April 2019 will earn a fixed rate of 0.50%, the highest in 10 years, the U.S. Treasury announced this morning.
The fixed rate is, in essence, the I Bond's "real return," the interest earned above inflation. The new rate of 0.50% is the highest fixed-rate reset since November 2008, when the Treasury set it at 0.70%.
Combined with the I Bond's new inflation-adjusted variable rate - 2.32% - that goes into effect on November 1, I Bonds purchased from November to April will earn a composite rate of 2.83% for six months. Here is the wording from the Treasury announcement:
The composite rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the 30-year life of the bond, and the semiannual inflation rate. The 2.83% composite rate for I bonds bought from November 2018 through April 2019 applies for the first six months after the issue date. The composite rate combines a 0.50% fixed rate of return with the 2.32% annualized rate of inflation ... "
Why do rates of 0.50% and 2.32% combine to form 2.83%? The Treasury adjusts for accrued interest, and here is the exact formula it uses:
I track the spread between the fixed rate on I Bonds and real yields on 5- and 10-year Treasury Inflation-Protected Securities, and those widening spreads made today's decision by the Treasury a no-brainer, in my opinion.
I Bonds remain attractive
Today's announcement is very good news for I Bond investors, even for those who have already purchased their allocation for 2018. (The Treasury limits purchases to $10,000 per person per year.) But that clock restarts on January 1, so all investors will have access to the 0.50% fixed rate through April.
A fixed rate of 0.50% on I Bonds - which are among the safest investments in the world - keeps them competitive with 5-year and 10-year Treasury Inflation-Protected Securities, which currently have real returns of 1.08% and 1.10%, respectively. The after-inflation return on I Bonds typically lags the return on TIPS by at least 50 basis points, and sometimes well over 100 basis points. Why? The I Bond has advantages of flexible maturity, tax deferral and solid deflation protection, so some spread is justified.
Once the fixed rate reaches 0.50%, I Bonds are very likely to match or outperform inflation, even after income taxes are paid, as long as inflation continues in a moderate range. Today's inflation rate is 2.3%, equating to a return of 2.8% on an I Bond, which is about 22% higher than inflation.
Anyone who follows I Bonds but hasn't made a purchase in 2018 should plan to do so before the end of the year.
As for 2019, I'm sure many investors will decide to jump aboard in January, grabbing the higher fixed rate right away. Another option would be to wait until mid-April, when we will learn the next variable rate to go into effect May 1. We can then also get an idea of the likely new fixed rate. I'd recommend waiting until mid-April, unless you have free cash you want to put to work.
Another option: Redeem some of your I Bonds paying a fixed rate of 0.0% to reinvest in the new, higher fixed rate. I'll be tempted to do that, but there are two negatives: 1) you will incur an income tax bill on the interest earned, and 2) you won't be able to increase your overall holdings of I Bonds. You are always limited to purchasing $10,000 a year per person, even if you sell and reinvest. (There is also the option of another $5,000 in paper form in lieu of a federal tax refund.)
Update on EE Bonds
The Treasury also announced today that EE Bonds will continue to pay a fixed rate of 0.10%, which is, honestly, an insult to EE investors. But that fixed rate really doesn't matter, because EE Bonds should only be purchased by people who can hold them 20 years - absolutely, positively - and then redeem them. After 20 years, they double in value, creating a return of about 3.5%, tax-deferred. Here is the Treasury's wording:
Series EE bonds issued from November 2018 through April 2019 earn today’s announced rate of 0.10%. All Series EE bonds issued since May 2005 earn a fixed rate in the first 20 years after issue. At 20 years, the bonds will be worth at least two times their purchase price.
In recent years, that 3.5% return on EE Bonds could not be matched in the Treasury market, even by 30-year Treasurys. That's still true today, with a 20-year Treasury yielding 3.30% and a 30-year at 3.39%. But the margin is getting slim, meaning that EE Bonds are losing some of their appeal.
As an alternative, you can go with a 2-year Treasury yielding 2.87% or a 2-year best-in-nation bank CD yielding 2.90%.
Again, the fixed rate of 0.1% ensures that EE Bonds should only be purchased if the investor is absolutely positive they can be held 20 years, and then redeemed.
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