The Gift That Now Gives Less
With a new rate formula, U.S. Savings Bonds lose appeal
(MONEY Magazine) – One of the most enduring and popular investments--and a favorite of gift givers--has undergone a makeover, and it doesn't look pretty. Just as interest rates are on the rise, Series EE savings bonds have switched from paying a variable rate to a fixed rate. Savers, as a result, may want to look elsewhere for high yields.
Savings bonds still have the features investors love: You can buy one for as little as $25 from your bank, your employer (through payroll deduction) or directly from Uncle Sam at treasurydirect.gov. You won't owe state and local tax on the interest, and federal tax is deferred until you cash the bond in or it stops earning interest.
What's gone, however, is the chance to benefit from rising rates. As of May 1, Series EE savings bonds will pay a fixed rate for the entire 20-year term. Every six months (on May 1 and Nov. 1) the Treasury Department will set the payout for new bonds--the current rate is expected to be about 4%. The bonds are guaranteed to double in value by maturity, which effectively means a 3.5% minimum compound rate if you hold on for 20 years. Previously, savings bond rates fluctuated every six months, and any bonds you bought before May 1 will still earn that variable rate (an estimated 3.4% after May 1, up from 3.25%).
How the Bonds Stack Up
At first blush, a 4% fixed rate may sound like a good deal. But keep in mind that you're locking up your money (you give up three months' interest if you cash in the bond in years two through five). If you're saving for the long term, you can do just as well with a five-year certificate of deposit--the highest yielding pay 4.8%, according to Bankrate.com (see page 49).
More important, with the Federal Reserve expected to continue raising short-term interest rates, today is not the time to lock up your money at 4%. If the Fed keeps it up, says Dan Pederson, president of the Savings Bond Informer, a bond consulting service, "that rate could quickly become unattractive." When rates are high, locking in a fixed rate for 20 years may be wise. But today you can earn well over 3% in a six-month CD and, assuming that rates keep rising, reinvest at a higher rate at the end of the term.
A Savings Bond Strategy
Does this mean you should give up on U.S. Savings Bonds? Not necessarily. While EE bonds are less attractive now, I bonds can still make sense. They pay a fixed rate (recently 1%) plus a variable rate tied to inflation and adjusted semiannually. Pederson says the combination could reach 4.2% on May 1, the next adjustment date. Since inflation tends to track interest rates, I bonds give you a shot at catching higher yields as rates rise.