I write fairly often about U.S. Savings Bonds, especially inflation-protected Series I Savings Bonds, and the reaction I get from some Seeking Alpha readers is: "Why the heck is this guy writing about Savings Bonds?"
OK, I get it. Savings Bonds are probably the most safe, most elementary, most basic, and most boring investment in the world. But the thing is ... they are also an excellent investment opportunity in July 2019. Don't believe me? Read on.
Yields across the board in the international bond market have plummeted in 2019. The yield on a 10-year U.S. Treasury has dropped 62 basis points so far this year, down to 2.04% as of Friday. A 10-year German bund is currently yielding -0.36%. Yes, that is negative 0.36%. The same bond in Japan will get you -0.17%. In Switzerland, -0.67%.
Meanwhile, U.S. Savings Bonds continue to earn exactly what they were yielding in November 2018, the last time their terms were changed. Those yields are stuck in time and won't be updated until at least November 1, 2019. Here are the current terms:
- U.S. Series I Bonds pay a composite interest rate that combines a fixed rate (currently 0.50%) with an inflation-adjusted variable rate (currently 1.40%, annualized). So the current composite rate is 1.9%. When you buy an I Bond, the fixed rate remains with that bond until you redeem it or it matures in 30 years. The variable rate changes every six months, to reflect current U.S. inflation.
- U.S. Series EE Bonds pay a fixed rate of 0.1% that never changes. Obviously that is horrible. However, terms of the EE Bond guarantee that your investment will double if held for 20 years. So ... if you hold an EE Bond for 20 years, you get a return of about 3.5%. The goal is to hold them 20 years, and then immediately redeem them.
Think of these investments this way:
An I Bond is an inflation-protected investment that offers a real return (meaning above inflation) of 0.5%. It can be redeemed in one year with a small interest penalty, or anytime after five years with no penalty. Plus, I Bonds have one big advantage over Treasury Inflation-Protected Securities: They lose zero money during times of deflation. TIPS see their accrued principal fall during months of deflation.
An EE Bond is a nominal investment that will pay, in effect, a compound interest rate of 3.5% if held for 20 years. But it has to be held for 20 years and then redeemed. Anything less, and you earn 0.1%. Anything more, and you get 0.1% on your doubled money.
Both also have purchase limits of $10,000 per person per calendar year.
The numbers, in depth
Why are Savings Bonds suddenly appealing? The key is that I Bonds and EE Bonds are offering the same terms they were in November 2018, when the yields in the overall bond market were much higher.
I Bonds. Here is a chart comparing the I Bond's current real return of 0.5% to the yields on 5-, 10- and 30-year TIPS, since May 2018:
Once the real yields of 5- and 10-year TIPS dipped below 0.50%, the I Bond became the superior investment. It has a higher real yield while also offering benefits of tax-deferred interest, rock-solid deflation protection and a flexible maturity.
How about a 30-year TIPS? I personally wouldn't invest in a 30-year TIPS with a real yield of 0.78%, where it stands today. It should be yielding at least 100 basis points higher than the I Bond. The I Bond is a safer, simpler investment, and the flexible maturity makes it much more desirable.
EE Bonds. The case for EE Bonds as a nominal investment is even more rock solid, and as long as the investor is positive, the bond can be held for 20 years, when its value doubles. Here are the exact terms from the Treasury announcement on May 1, if you are interested:
Series EE bonds issued from May 2019 through October 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. The bonds will continue to earn interest at their original fixed rate for an additional 10 years unless new terms and conditions are announced before the final 10-year period begins.
Doubling in 20 years creates an effective nominal yield of 3.5%, far above any similar 20- or 30-year Treasury investment, as this chart shows for yields back to May 2018:
Again, EE Bonds offer the huge advantage of deferral of federal income taxes. They are an ideal investment, in my opinion, for a 40-year-old who is 20 years away from retirement. Invest, hold for 20 years, collect double your money, then redeem. A couple could put away $20,000 a year each year starting at age 40 and then collect $40,000 a year at age 60. No other Treasury investment offers a return of 3.5%.
Of course, if you are 65 years old or older, maybe EE Bonds aren't for you, because the 20-year holding period would be daunting.
It's surprising, but it is a fact: When you balance all the factors, I Bonds are the most attractive inflation-protected investment with a maturity under 20 years, and EE Bonds are the most attractive nominal Treasury investment with a maturity of 20 or more years. Here are numbers to back that up:
This chart shows that I Bonds with a real yield of 0.5% will outperform all TIPS with maturities of less than 20 years, and a 20-year TIPS has just an 8-basis-point advantage despite the I Bond's superior side benefits of tax-deferral and deflation protection. Nominal Treasurys will outperform an I Bond as long as inflation remains at 1.0% or lower. Once inflation reaches 2.0% and above, nominal Treasurys begin earning negative real returns.
EE Bonds also offer an attractive "real" return all the way up to 3.0% inflation; at that level all other nominal Treasurys have real returns deep into the negative.
On the nominal side, EE Bonds at 3.5% outperform every Treasury investment, across the board, even those with 30-year maturities. But I Bonds and TIPS will begin outperforming an EE Bond once inflation surpasses 3.0%.
I Bonds are a popular investment with "wealthy" do-it-yourself investors who are looking for capital preservation; they allow an investor to push tax-deferred, inflation-protected money into the future. Plus, a fixed rate of 0.5% should come close to covering taxes owed in the future, meaning the investment truly tracks inflation.
Why do I say "do-it-yourself" investors? Because no stock broker or typical investment adviser is going to recommend I Bonds. Savings Bonds can be purchased directly at TreasuryDirect.gov with no sales fees, commissions or carrying costs.
EE Bonds, however, are universally disdained, even by savvy do-it-yourselfers. The fixed rate of 0.1% is a huge turn off, and a lot of investors aren't willing to stash money away for 20 years. But a nominal return of 3.5% - 116 basis points higher than a 20-year Treasury -- should be worth a serious look.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can be purchased through the Treasury or other providers without fees, commissions or carrying charges.