Yes, I am taking about the lowly and often-ridiculed U.S. Series EE Savings Bond, the one that carries a fixed interest rate of 0.1% for 30 years. If you read that and thought "0.1% interest? This guy is nuts!" I am going to ask for your patience. Please read on.
A lot of articles on EE Bonds dismiss them immediately because of that awful 0.1% fixed rate, which is actually irrelevant to the way EE Bonds work. These are the important terms laid out on the TreasuryDirect website:
Treasury guarantees that for an electronic EE Bond with a June 2003 or later issue date, after 20 years, the redemption (cash-in) value will be at least twice the purchase price of the bond. If the redemption (cash-in) value is not at least twice the purchase price of the electronic bond as a result of applying the fixed rate of interest for those 20 years, Treasury will make a one-time adjustment at the 20 year anniversary of the bond's issue date to make up the difference.
These terms guarantee that your EE Bond investment will double in value if held for 20 years. So, hold an EE Bond for 20 years and you get a return of about 3.53%, compounded and tax-deferred. The goal is to hold them 20 years, then immediately redeem them. After the doubling, the EE Bond interest rate reverts to 0.1% until full maturity in year 30.
So here is the ONLY way to invest in an EE Bond: Buy it today. Hold it 20 years. Double your money. Immediately redeem it.
A massive yield advantage
Obviously, an EE Bond paying 0.1% interest will not double in 20 years; in fact that would take about 138 years of compounding. The Treasury's 20-year "doubling" has been in effect since June 2003, when it raised the holding period from 17 years. For perspective, the 20-year Treasury was yielding 4.36% in June 2003, 259 basis points higher than today's 1.77%.
And that is the reason EE Bonds have become a stellar investment in September 2019: Their rate of interest has held steady, while yields on nominal Treasurys of the same term have plummeted 250+ basis points. In 2003, investors were justified for scoffing at EE Bonds, but no longer. Take a look at the yield advantages of EE Bonds against similarly safe U.S. and world bond investments:
Obviously, EE Bonds have a 20-year holding period, and if you aren't absolutely positive you can hold them 20 years, they don't make sense as an investment. If you hold them 19 years, 11 months and then redeem, you will earn 0.1%. Hold them one month longer and you earn 3.53%.
Also, this is an investment created for small-scale investors. The Treasury limits purchases to $10,000 per person per year, purchased in electronic form at TreasuryDirect.gov. A married couple can purchase $20,000 a year, but will need separate accounts at TreasuryDirect.
This investment makes sense as part of an overall retirement strategy. An investor could begin buying EE Bonds at age 45 and begin drawing down double his money at age 65. But as an investor gets older, the 20-year holding term begins to look daunting. Buying them after age 70 probably isn't wise.
Many investors have scoffed at EE Bonds in the past because they expected interest rates to begin rising above the 3.5% level and they'd get stuck with the lowly EE Bond for years. But since the end of the Great Recession, 20-year Treasury yields have rarely topped 3.5%, and so for much of the time the EE Bonds have been a better investment.
My question: Who is actually buying 20-year Treasurys with yields this low? I suspect these aren't buy-and-hold investors, but traders who expect yields to decline even lower, providing a capital gain. An EE Bond has no secondary market and is never "marked to market" so it has zero appeal for traders.
What are the positives?
This is pretty simple:
- EE Bonds are a supremely safe investment, with the full backing of the U.S. government.
- EE Bonds have a huge yield advantage versus similarly safe investments of the same term around the world.
- Federal income taxes on interest earned through EE Bonds is deferred until the bond is redeemed or matures in 30 years.
- The investment can be free of federal income taxes if the proceeds are used for qualified education expenses.
- Like U.S. Treasurys, interest from all savings bonds is excluded from state income taxes.
- EE Bonds carry zero sales commissions or holding charges.
- They can be purchased in amounts as low as $25.
Conclusion: Right for the right investor
EE Bonds, if held for 20 years, offer a large yield advantage over similarly safe investments of the same term. For the person who can hold them 20 years, they make a lot of sense as part of a fixed-income asset allocation. For anyone unsure about the holding period, EE Bonds aren't a smart investment.
Honestly, EE Bonds are just the same as they have always been: A simple product for a small-scale investor, providing a "modest" return. But in today's market, that modest return has become stellar.
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.