The Old Savings Bond Switcheroo
The Treasury Department revamps the Series EE rate
Ever since President Franklin D. Roosevelt kicked off the modern era of savings bonds in 1941 by purchasing the first of a new World War II bond, buying has typically been spurred by a mix of patriotism, nest-egg building, and investment strategy. During World War II, for example, Hollywood celebrities pitched in to push sales to levels never matched. Irving Berlin even composed a fundraising ditty, "Any Bonds Today?" During the Vietnam era, ads for payroll-deduction plans urged employees, "Buy Bonds Where You Work. They Do," trumpeting the fact that soldiers were buying bonds.
In recent years, however, the investment aspect has gotten more play. Slumping sales were reversed after the government in 1982 switched from a fixed rate of interest on Series EE bonds to a more competitive variable rate that fluctuates in line with rates on other federal securities. Annual sales of bonds got another lift after the introduction in late 1998 of the I bond, a hybrid that pays a base fixed rate plus a variable rate to match inflation.
The supersafe EE and I bonds, $7.9 billion of which were sold last year, are available for as little as $25. Though sales this year have been sluggish, bonds have been a constant for many risk-averse or habitual savers, with about 40 percent of overall purchases through employer-encouraged payroll deductions. Holders of the bonds do not collect the accrued interest until they cash out the bonds. Counting built-up interest, about $177 billion of EE and I bonds are outstanding today.
But EE bonds face a new viability test this week, as the government reverts to paying a fixed interest rate instead of a variable one. Any EE bond sold as of May 1 carries a permanent rate that the Treasury Department will determine by reviewing the return on 10-year treasury notes and other factors. A new rate can be established every May and November, but once set, any EE bond sold until the next change will pay that rate for at least 20 years. If that rate isn't enough to double your money over that period, treasury will make up the difference 20 years out, provided you've hung on that long. In effect, that guarantees a minimum annual return of roughly 3.5 percent. Existing EE bonds aren't affected by the change. (For more information on bonds and rates, visit publicdebt.treas.gov.)
Of course, locking in a return isn't favorable to savers during a period of rising interest rates, the scenario now forecast by many economists. But nailing down a rate can be a plus for Uncle Sam, who, as a borrower, can avoid the full brunt of higher interest costs.
The new calculation accentuates the difference between the EE and its inflation-adjusted cousin. Analysts are waiting to see how rates and inflation play out. Many say that I bonds, which already outsell EE s, could steal more customers because of their better potential return during inflationary times. However, Washington's continuous fiddling with the I-bond premium over inflation, which dropped from 3.6 percentage points in 2000 to just 1 percentage point last May, could cloud the choice.
Niche. Despite the changes, EE and I bonds can serve a tortoise like role in a portfolio by earning income that can help balance volatility in other areas, says Thomas Wargin of Liberty Financial Group in Elm Grove, Wis. He also likes being able to defer U.S. tax on the interest until the bonds are cashed in and to wholly escape state tax.
Bonds aren't as easy to get in and out of as, say, a money market fund, but they can offer better yields for part of a portfolio's cash holdings, says Ray Benton of Lincoln Financial Advisors in Denver. One hurdle: You can't cash in a bond until you've held it a year. And there's a penalty of three months' interest if redeemed before five years.
The penalty shouldn't deter you, says Daniel Pederson of the Savings Bond Informer in Detroit, which sells custom analyses of bond holdings. Even after a penalty, the return may work out to be favorable. People who buy new EE bonds may have to rebalance them to achieve top performance, says Pederson. That can mean cashing out if the rate loses punch and reinvesting in higher-paying bonds. One thing not to do, he says, is to automatically dismiss savings bonds as not worth the bother. Remember Grandma: She has never stopped loving them.
This story appears in the May 9, 2005 print edition of U.S. News & World Report.
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