May 2011 I-Bonds As a Good 11-Month CD Paying 2.5% Or More

By Harry Sit

Every May and November, the US Treasury announces new rates for Series I savings bonds (I-Bonds). The inflation adjustment is based on CPI changes between September and March.

The Bureau of Labor Statistics announced the CPI numbers for the month of March 2011. CPI-U was 223.467. Compared to the September 2010 number of 218.439, it’s an increase of 2.3% in six months.

Although the fixed rate is unknown, it’s likely to be zero again. Even if the inflation adjustment for the second six months is zero, I-Bonds bought toward the end of May will be a good 11-month CD.

In the worst case, you earn 4.6% annualized rate for six months and 0% for six months. When you redeem the I-Bonds on May 1, 2012, you pay the last three months of interest as penalty, which is zero. Over a 11-month period, you earn

4.6% * 6 / 11 = 2.51%

That’s a great rate for a 11-month CD. If the inflation adjustment for the second six months isn’t zero, you will earn more. You also get state tax exemption on the interest earned.

I set myself a reminder on the calendar to buy I-Bonds on May 25 (leaving a few days of wiggle room).

Too bad you can only buy $5,000 per person in paper and another $5,000 per person electronically. I resisted the draconian security scheme set by TreasuryDirect until now. Maybe I will finally take the plunge.

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Posted on April 15, 2011 under Investing. Keywords: .

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Comments

15 Comments on May 2011 I-Bonds As a Good 11-Month CD Paying 2.5% Or More

  1. AM on April 15, 2011
     

    Interesting tip, I’ve never considered treasuries before, probably because CDs are advertised everywhere but I never bothered to figure out how treasuries work or how to buy them.

    But wouldn’t you expect CD rates to go up as well? In fact they could be higher because a) they must pay more to compensate for the state tax break on bonds, and b) you describe the worst case, not the statistical expected return.

  2. KD on April 15, 2011
     

    I need to find my magic card for that log in! Oh boy, I better start looking that up now.

  3. TFB on April 15, 2011
     

    @AM – Banks set CD rates on their own. They don’t have to set them competitively with I-Bonds. Most people don’t know I-Bonds because Treasury doesn’t have a big marketing budget. There is a purchase limit anyway. I don’t think CD rates will be as good as May I-Bonds.

    @KD – Thank you for the reminder. It looks like I won’t be able to buy until I receive that magic Access Card in the mail. So if I decide to buy electronic bonds in addition to paper, I will have to open the TreasuryDirect account well ahead of time.

  4. nickel on April 15, 2011
     

    What do you think about the longer term prospects of the fixed rate? Are we doomed to low rates going forward, or do you think they’ll eventually get more generous? We need to buy some more I bonds, but will likely wait for November if the fixed rate stays at zero this time around.

  5. TFB on April 15, 2011
     

    @nickel – Eventually it will go above zero but probably not in November. The 5-year TIPS is -0.65% right now. I-Bonds fixed rate has traditionally been lower than 5-year TIPS yield (and it should be because of short lock-in and tax deferral). I would buy in May and consider sell-and-rebuy in May 2012 if the fixed rate is no longer zero then.

  6. Investor Junkie on April 16, 2011
     

    TFB,

    which do you think is a better deal, IBonds or TIPS?

  7. TFB on April 17, 2011
     

    @Investor Junkie – For short-term money, I-Bonds. TIPS yields are negative for issues maturing before 2017 whereas I-Bonds fixed rate is 0%. For longer-term money, TIPS. I have 2028 TIPS at 1.4-1.5% above inflation, not great, but better than 0% I-Bonds.

  8. Investor Junkie on April 17, 2011
     

    TFB,

    Short term: less than 5 years?

  9. TFB on April 17, 2011
     

    @Investor Junkie – At current yields, less than six years. You get better yield and more flexibility in I-Bonds.

  10. Retirement Income on April 18, 2011
     

    Right now, I’m scared of inflation. The government is running record deficits, and paying for them by borrowing and printing money – “quantitative easing.” This is a prescription for inflation and rising interest rates. The Federal Reserve has begun a program of “reverse repos” – making banks buy Treasury debt to take cash out of the banks. Worst, Bill Gross, head of the huge bond firm PIMCO, has dumped all or most of his Treasury debt. He thinks that after “QE2″ – the latest round of money printing – ends on June 30, the bottom may fall out of the Treasury market. This may all be alarm without cause. I hope that’s all it is, for the sake of the country. Still, as an investor, I don’t like bonds when interest rates are so low – they have nowhere to go but up. Just my take. I appreciate the chance to discuss this.

  11. edward on April 18, 2011
     

    I just called Fidelity to see why I couldn’t get into the 912828QD5 (5 Yr TIPS) auction on Thursday for my IRA & 401k. Not listed due to negative yield, they said. I thought that couldn’t happen at initial auction, only reopenings, and so called TD for clarification, as I thought I had seen a contradictory statement from Treasury. Fidelity is correct, Treasury will set *coupon* to a minimum of 0.125%, but price can still be above par such that HTM produces a negative real yield. Kinda blew up my grand investing scheme. I used to wonder if there was a way to predict the I Bond fixed rate from the just prior 5yr TIPS, as they are comparable. I think TFB is right, we’re gonna see 0% fixed I Bonds on May 1.

  12. TFB on April 18, 2011
     

    @edward – I wrote about the upcoming 5-year TIPS auction on my Explore Bonds site. Is it a technical limitation that Fidelity can’t list the auction? If you still want it, can a rep place the order for you? Just curious. I won’t buy it anyway.

  13. edward on April 18, 2011
     

    The explanation was that it was deliberately precluded from online order because of the expected negative yield. I did initially place an order via a rep, then canceled it before I called TD. I found the Federal Register (Sept 2004) explanation, and realized I had confused interest rate, which can’t be zero, and yield, which can (and probably will be, as was the previous 5yr reopen in October). I’ll pass on the 5 yr, and hope the 10yr in July is better. I’m reluctant to go longer, as I prefer to always have the HTM option, but I’m not that young :) .

    On a related subject, one of my options now is to go back to a TIPS index fund in my 401k, but am I correct in guessing that ship has sailed? My recent 5yr and 10yr TIPS purchases are showing nice short term returns, but it’s not real unless I sell. Then what?

  14. TFB on April 18, 2011
     

    @edward – Buying a TIPS fund is like buying a bundle of TIPS of different maturities. Some of the short-term notes have a negative real yield; some longer-term ones have a positive real yield. You get a mixture. TIPS don’t turn themselves into a positive real yield just because a fund is holding them. So I would agree that ship has sailed.

    However, as I mentioned in the other post, you have to consider the alternatives. Nominal Treasuries aren’t any better.

  15. slug on April 22, 2011
     

    Just re-activated my TD account after 4 years (used to do T-bill ladders when it was worth it). Their security is still a total pain in the ass, and the site is far from user-friendly. Guess I’ll start transferring around May 20.

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