New inflation numbers for March 2009 were announced today, so it’s time for the usual semi-annual update:

New Inflation Rate
September 2008 CPI-U was 218.783. March 2009 CPI-U was 212.709, for a semi-annual decrease of 2.78%. Using this official formula, the variable interest rate for the next 6 months will be approximately -5.55%, depending on the fixed rate. What does this deflation mean for the investment returns for I-Bonds?

Buying Now = ~3.08% APR, 11-month investment
If you buy before the end of April, the fixed rate portion of I-Bonds will be 0.7%. You will be guaranteed an variable interest rate of 4.94% for the next 6 months, for a total rate of 5.64%. For the 6 months after that, the total rate will be zero, not -4.85%. This is due to the 0% floor on savings bond rates.

You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur a 3-month interest penalty. However, a known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. Let’s say we buy at the end of this April, hold for the minimum of one year, and pay the 3-month interest penalty for redeeming within 5 years. You’ll be able to sell on April 1, 2010 for an actual holding period of 11 months.

This would leave you with a 5.64% return on your money for 6 months, and then nothing for 5 months. Overall, that’s a 3.08% annualized return, and you will be exempt from state income taxes on the interest as well. This is very competitive with current bank CD rates.

Buying Later? If you wait until May 1st, you will get a new unknown fixed rate minus 5.55%, for a virtually guaranteed composite rate of zero for the first 6 months. (The next 6 months will be based on an unknown rate based on future inflation.) Unless there is a big bump in the fixed rate that makes it a good long-term investment, sticking with banks or credit unions will likely give you a higher yield.

Low Purchase Limits
The annual purchase limit is now $5,000 in paper I-bonds and $5,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. Buy online at TreasuryDirect.gov. As for paper, here is a post on how to buy paper savings bonds from your local bank. Some larger banks may have an electronic process.

For more background, see the rest of my posts on savings bonds.

The new fixed rate for Series I Savings Bonds (“I Bonds”) was announced on Monday to be 0.7%. A few readers asked if I thought this was a good time to buy.

As a long-term investment, a 0.7% real yield makes I-Bonds a poor choice, as you can buy TIPS with much better yields. As of yesterday, a 5-year TIPS had a 3.66% real yield.

As a short-term investment, it depends on how you think inflation will turn out in the near future.

If you buy now in November, you will earn 0.7% fixed + 4.94% based on inflation = 5.64% for the first 6 months. The second 6-month rate will be 0.7% + a variable rate based on inflation from September 2008 to March 2009. So far, the markets seem to suggest that there is a decent possibility that there might even be deflation for this period. Reminders: You must hold for at least a year (or 11 months and a day if you buy on the last day of the month). If you hold for less than 5 years, there is a penalty of the last 3-months interest.

Worst case scenario, there is deflation of worse than 0.7% which makes the total rate zero for the 2nd six months. Earning 5.64% for 6 months with an 11-month holding period gives you only an effective 3.07% APY. If say, inflation is 1%, you’d get an effective 3.54% APY for the minimum 11-month hold. Even if this is exempt from state taxes, the tax-equivalent yield won’t be far above 4%. You can do better with bank CDs.

The only scenario where I-Bonds may be better than what you can get from a bank is if you think annualized inflation will be higher than 1.5% over the next 6 months. Personally, combined with the lack of short-term liquidity, I don’t think I’d take that bet right now.

For more background, see my last post on savings bonds.

New inflation numbers are out, so it’s time for the usual semi-annual update:

New Inflation Rate
March 2008 CPI-U was 213.528. September 2008 CPI-U was 218.783, for a semi-annual increase of 2.46%. Using this official formula, the variable interest rate for the next 6 months will be approximately 4.92%.

Buying Now? If you buy before the end of October, the fixed rate portion of I-Bonds will be 0%. You will be guaranteed an variable (well… total) interest rate of 4.84% for the next 6 months, and 4.92% for the six months after that. You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur a 3-month interest penalty.

A known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. Let’s say we buy on October 31st. You’ll be able to sell on October 1st, 2009 for an actual holding period of 11 months. (3-month interest penalty still applies.)

Not bad as a place for short-term cash reserves, but not necessarily the best. There are certificates of deposit with comparable interest rates, and you can still access your money early in an emergency.

Buying Later? If you wait until November 1st, you will get a new unknown fixed rate + ~4.92% for the first 6 months, and an unknown rate based on ongoing inflation after that.

Bought already? For those that bought back in April when the fixed rate was 1.2%, the next reset rate will be 1.2% + 4.95% = 6.15%. So we got 4.38% from April-September, then 6.06% from October-May, and now 6.15% from April-September ’09. And this is not counting that the interest is exempt from state income taxes. Yep, I’m keeping these for another 6 months. 🙂

Beware Low Purchase Limits
The annual purchase limit is now $5,000 in paper I-bonds and $5,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. Buy online at TreasuryDirect.gov. As for paper, here is a post on how to buy paper savings bonds from your local bank. I am already nearly maxed out for this year already, and don’t think I’ll be buying any more.

Wow, harsh. No wonder they finally started to enforce the buying limits recently. Hope people bought what they could in April.

While on my lunch break, I went over and bought some Series I Savings bonds, due to their high interest rates described here. Technically I had two more days until the 30th to get an April 2008 issue date, but I didn’t want to cut it too close in case there were any problems. I was also fueled by the news that interest rates will probably dropped yet again soon by Bernanke and Co.

Here’s how to do it:

1) Find a bank near you that sells paper savings bonds. Although the TreasuryDirect website says “any financial institution”, not all banks participate. I asked a few smaller ones near work and they did not carry them. The big boys like Bank of America, Washington Mutual, Chase, or Wachovia should all have them. If you don’t have one of these megabanks, just call the biggest banks in your region.

2) Either move funds into an account there, or bring cash. You can’t write a check from another institution, because they need to have the funds immediately. Although I didn’t try, a cashier’s check should work, assuming the bank can simply turn that into cash. I just had them withdraw the funds out of my bank account.

3) Ask for the Series I Savings bonds order form. Don’t be surprised if the teller looks confused, as this isn’t a popular request. Have them ask a supervisor, it should be Form 5374. I had one left over, so here is a scan of what it should look like:

(Some larger banks may have an electronic process.)

Remember, the limit for paper bonds is $5,000 per Social Security number per year. So you can put down $5k for you and $5k for your spouse if you have one, and simply pay $10,000 by yourself. You may also wish to buy something like five $1,000 bonds instead of one $5,000 bond for ease of paper redemption.

The issue date of the savings bond will be the same day that the bank accepts payment. This date will be noted on the application, and the bank should also stamp it to confirm.

4) Wait. The forms says that processing will take 3 weeks, and then it will be mailed to you. You can have it sent to a P.O. Box if you have one, for more security. The processing time won’t affect your interest earned because again as long as you paid in April it will be stamped as issued in April 2008. Also, you can’t cash out until after 12 months, so there is no hurry.

How do I redeem them?
You can either convert these paper bonds to electronic format at TreasuryDirect and redeem online, or cash them in at the same place you bought them (or any other financial institution that sells them). The cool thing about electronic format is that you can do partial redemptions.

It’s now six months since April, which means it’s time again to partially predict the new I-Bond savings bond rates before the formal announcement until November 1st. Just in case we want to buy some beforehand and lock in some rates.

The CPI-U in March 2007 was 205.352.
The CPI-U in September 2007 was 208.490.

208.490/205.352 = 1.015281, or a semi-annual increase of 1.5281%.

Total rate = Unknown fixed rate + 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)

If we assume a fixed rate of the current 1.3%, we get

Total rate = 0.013 + (2 x .015281) + (.013 x .015281) = 1.3% + 3.08%
Total rate = 4.38%

Overall, if you buy now in October and lock in your 1.3% fixed rate, you?ll get 3.74% for 6 months and then 4.38% for another 6 months. Not very appealing. Here to hoping the fixed rate jumps some…

Just like last last April, using the newly released March CPU-I data and the information in my How To Predict I-Bond Savings Bond Rates post, we can now try to predict the upcoming I-Bond rate announcement on May 1st.

The CPI-U in September 2006 was 202.9.
The CPI-U in March 2007 was 205.352.

205.352/202.9 = 1.012085, or a semi-annual increase of 1.2085%.

Total rate = Unknown fixed rate + 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)

If we assume a fixed rate of the current 1.4%, we get

Total rate = 0.014 + (2 x .012085) + (.014 x .012085)
Total rate = 1.4% + 2.43%
Total rate = 3.83%

For those with existing I-Bonds, the variable rate is about 2.43% on top of your fixed rate. Note that the rate on your bonds changes every six months from the date you bought it, so it might not change immediately in May.

Overall, if you buy in April and lock in your 1.4% fixed rate, you’ll get 4.52% for 6 months and then 3.83% for another 6 months. If you wait until May, even if the fixed rate portion rises to 1.6%, the total rate will barely break 4%. Either way, as a short-term safe investment it’s not a very competitive rate. Unless there is a big jump in the fixed rate to make this an interesting long-term investment, I’ll see you in six months…

As suggested by my When Should You Redeem I Savings Bonds Calculator, I redeemed a $5,000 I-Bond purchased in October 2005 on Tuesday. I ended up receiving $298 in interest over a holding period of 14 months (I bought at the very end of October). Since the interest is exempt from state-income taxes, my effective interest rate was around 5.8%. I did it all online at TreasuryDirect.gov and the money should be in my bank account within two days.