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August Inflation Numbers and Impact to Series I Savings Bonds

POSTED ON BY

Rising inflation and falling deposit rates punishes savers. We have been seeing the falling deposit rates for the last three years, and this year rising inflation has been very apparent even in the government reports. You can see the rising inflation in the August CPI numbers that the Labor Department released yesterday:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in August on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.8 percent before seasonal adjustment.

Note the 3.8% increase for the year. That's high. The LA Times blog Money & Company has a good overview of August numbers:

U.S. consumer prices were up more than expected in August, lifting the year-over-year inflation rate to the highest level in three years.

The Consumer Price Index rose 0.4% in August from July, seasonally adjusted. That was double the 0.2% rise that economists had expected in a Bloomberg News survey.

It should also be noted that the core CPI, which excludes energy and food, rose 0.2% in August and 2% for the last 12 months. That's at the high end of the Fed's informal inflation target. This will make it harder for the Fed to justify QE3.

Series I Savings Bonds

One small benefit of rising inflation is that it makes Series I Savings Bonds a better deal. The next inflation component of the I bond will take effect in November, and this component will be known in mid October. The Savings Bond Advisor gave an estimate of this inflation component:

The Series I bond inflation component is based on the difference between the March and September levels of the CPI-U. If the CPI continued to increase at this rate next month, the next I bond inflation component would be 3.31%.

The current I bond inflation component is 4.60%. If you buy an I bond before November, you'll receive 6 months with an annualized yield of 4.60% (fixed rate is zero). For the second 6 months, you'll receive the next I bond inflation component. If we use the estimate of 3.31%, we can calculate the return for 12 to 15 months.

In summary, an estimate for the 1-year yield for an I bond purchased before November is around 3.40%.

Here's how one would purchase and redeem the I bond to obtain this yield:

  • Purchase I bond at end of September or the end of October 2011
  • Receive 6 months with yield of 4.60%
  • Receive 3 to 6 months with estimated yield of 3.31%
  • Lose last 3 months of interest for early redemption
  • Redeem I bond early in the month to maximize short-term yield

Note, buying the I bond late in the month and redeeming it early in the month provides a slight bump-up in the short-term yield.

When I estimated the yield in May, I assumed the worst case yield for the second inflation component (zero percent). This resulted in a maximum yield of 2.51%. Please refer to my May I bond post for details about how I calculated the yields and how late in the month you can purchase a savings bonds.

The good news is that I bonds will provide a nice short-term return (estimated to be around 3.40%). The bad news is that you can only invest a maximum of $10,000 per social security number ($5K electronic and $5K paper).

Don't forget that next year you will no longer be able to buy paper savings bonds from banks.



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Comments
9 Comments.
Comment #1 by Anonymous posted on
Anonymous
I purchased an I- Bond in April, 2011.  At the present the rate is .74 and the yield is .29.  I made this purchase on the projection provided by Ken that in May, 2011 the yield would be over 3%.  This never happened.  Am I missing something?

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Comment #2 by KenBDG posted on
KenBDG
Please refer to my April 15th blog post and the section "I Bond Rates of Return for April 2011 Purchase".

3
Comment #3 by Saver posted on
Saver
Even though selling I bonds after 12 months might provide a good short term rate of return, it might be wiser to hold onto them.  They are a good inflation hedge, and if inflation increases over the next few years as many expect, they would provide much better returns than many other medium-term, fixed rate investments currently available. 

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Comment #4 by enough money to live on (anonymous) posted on
enough money to live on
all i ever here is that i will run out of money  is there a website or a formula one can use to predict with a high rate of certainty as to whether or not this could be a worse case scenario the favour of a reply is appreciated

1
Comment #5 by melman posted on
melman
1. The what-if projection of 3.31% for the next inflation component supposes that next month's CPI increase will be exactly the same as this month's increase (0.623 CPI points).  Of all the possible numbers to pick for an estimate, this one isn't terribly realistic or useful.

The CPI increase since March is 1.38%.  If CPI stayed unchanged next month, the next inflation component would be 2.76%.  Also unlikely... but using this more conservative guess shows that I-bonds will still earn more than any 5-year CD available right now. 

2. Looking at the "1-year yield" of an I-bond is kind of pointless.  Yes, it can be done... but why not compare to 5-year CD's?  At 5 years, I-bonds can be cashed without penalty.

The first time the fixed component went to zero was May 2008.  A bond purchased then has had 6-month rates of 4.84, 4.92, 0, 3.06. 1.54, 0.74, 4.60.  Average rate=2.81%.    Again, better than 5-year CD's in the current environment.

But... since the purchase limit is falling to $5000, I fear that all this analysis just doesn't make much difference.

2
Comment #12 by Anonymous posted on
Anonymous
To #1 - The interest rate at the time of investment is good for the following six months.  By investing just before May 2011 you locked in the lower rate for six months.  So you should have waited till May to invest, when the rate was going be higher.  The fixed rate component is not a factor here since it's zero (and will likely remain zero).  The other aspect lowering your yield is the 3-month early withdrawal penalty (of the interest you've earned in the most recent 3 months).  By October 2012 your yield should be around 2.3%.

2
Comment #14 by Shorebreak posted on
Shorebreak
Re: enough money to live on - #4, Friday, September 16, 2011 - 2:52 PM

Try this calculator:

 http://www.dinkytown.net/java/RetirementDistribution.html

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Comment #15 by Paoli (anonymous) posted on
Paoli
Considering wanting to blame Ken for any misinformation we get on this forum, imo, anyone who takes financial advice from ANY forum or financial advisor and runs with it WITHOUT doing his/her own homework to make sure it is best for their purposes is the one with the problem.  When it comes to finances, if we are not paranoid and check and recheck everything we read or do, we are just looking for trouble.  I read these forums for ideas and information I may have missed someplace but then only "I" am responsible for the decisions I make financially unless someone purposely misguides me on a contract.  If we read the "Disclaimer" on the forum it tells us basically what I am posting.  I just think too many people don't take the time to read it.   Just my opinion.

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Comment #16 by CapitalClimate (anonymous) posted on
CapitalClimate
If you're willing to either hold to maturity or be subject to market rate fluctuation, Treasury Inflation-Protected Securities (TIPS) provide the same CPI rate of return without the purchase limit.  The one downside is that yield can be negative in case of deflation (unlikely in the current environment).  Like I-bonds, they have been issued with near-zero fixed rates lately.  There's an auction this Thursday for a 10-year maturity with 0.625% fixed rate.  They can be bought directly from Treasury or through a broker.  TIPS are especially good for tax-deferred accounts, since the increase in principal each year, although not received in cash, is subject to income tax.


http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

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