The Labor Department released the September CPI numbers today, and with these numbers, the next Series I Savings Bond inflation component can be computed. The I Bond inflation component taking effect in November should be 3.06%. This is down from the current rate of 4.60%. Inflation has gone down a bit, but it remained fairly high. That's good news for I Bond investors. The I Bond inflation component is added on to the I Bond fixed rate to derive the I Bond composite rate. The fixed rate is currently zero percent, and it's likely to stay this way in November.
The new rate makes an attractive no-risk opportunity. However, with the annual I-Bond purchase limit of $5,000 online and $5,000 paper, the opportunity is limited.
If you buy I Bonds before the end of October, you can know the rate you'll receive for the next 12 months. The interst rate for the first 6 months will be based on the current inflation component (4.60%). The next 6 months will be based on this new rate (3.06%). After that, it'll depend on future inflation numbers. The current fixed rate component of zero percent will stay the same for the life of the bond. I describe the details of calculating the expected return below.
I Bond Rates of Return for October 2011 Purchase
the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.
All previous CPI-U numbers are available from this government webpage. The CPI-U for March 2011 was 223.467. Last September 2011 CPI-U was 226.889. This is an increase of 1.53%. The annualized version of this is about 3.06%.
If you buy before November, you'll receive the current I-Bond fixed rate of 0% for the life of the I Bond. The inflation component will be added to this rate and will change every 6 months. The current inflation component is 4.60%, and the composite rate is 4.60%. Here's an estimate of the return for the next year:
- 4.60% from October 2011 through March 2012
- 3.06% from April 2012 through September 2012
I Bonds increase in value on the first day of the month. So on November 1st, you'll earn the interest for the full month of October. So for maximum return, it's best to buy I Bonds near the end of the month and redeem them early in the month.
If you redeem an I Bond before 5 years, you lose the last 3 months of interest. So based on this and the above numbers, if you buy an I Bond on October 28, 2011, the value of the I Bond on October 1, 2012 would be about 3.07% higher. For 11 months, this comes out to an annualized yield of about 3.34%.
Below is an estimated annualized return for I Bond redemptions from October 1, 2012 to January 1, 2013. It is assumed you will buy the I Bond on October 28, 2011 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.
- 3.34% - redeem on 10/1/12, 6mo of 4.60%, 3mo of 3.06%, and 3mo of 0% (penalty)
- 3.32% - redeem on 11/1/12, 6mo of 4.60%, 4mo of 3.06%, and 3mo of 0% (penalty)
- 3.30% - redeem on 12/1/12, 6mo of 4.60%, 5mo of 3.06%, and 3mo of 0% (penalty)
- 3.28% - redeem on 01/1/13, 6mo of 4.60%, 6mo of 3.06%, and 3mo of 0% (penalty)
The highest guaranteed rate would be an annualized return of 3.34% for about 11 months (from 10/28/11 to 10/01/12). Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. In May I described my experiment in seeing how late in the month I could buy an I Bond. I found you should make sure the purchase is no later than the second to last business day of the month.
Compared to CD Rates
As you can see, the above rates are much higher than any CD rate that you can get today. The best nationally available 1-year CD rate is 1.30% APY ($25K minimum) at Alliant Credit Union. The best nationally available 5-year CD rate is 2.75% APY ($100K minimum) at Firstmark Credit Union. These rates are accurate as of 10/19/2011, and they do not require a checking account.
Unfortunately, an exact comparison between I Bonds and long-term CDs is not possible. The reason is that the I Bond inflation rate changes every six months. For this short period of time from now to before November, we know the I Bond inflation rate for 12 months. We can only guess about the I Bond inflation rate after that. The best we can do is to make an estimate of the future inflation rates.
As an estimate, I've calculated the average I Bond inflation rate since the I Bond program began in September 1998. That average is 2.65%. Note, this takes into account the period in 2009 when the I Bond inflation rate was negative. Since the composite rate can never be negative, I used zero for this period in calculating the average.
If the future I Bond inflation rates match the past average, I Bonds should do well as compared to today's long-term CDs.
If you have older I Bonds, you probably have I Bond fixed rates higher than zero percent, and if you're fortunate enough to have purchased I Bonds before 2001, you probably have fixed rates over 3.00%. So those I Bonds are especially good deals in today's environment.
Remember the $10K Annual Purchase Limit
Before you get too excited, remember that the annual purchase limit is $5K for online and $5K for paper. So if you earn 3.32% APY for 12 months on $10K, the total dollar amount of interest is about $332. As a comparison, a $10K deposit into Ally Bank's 5-year CD (at 2.00% APY) would return about $200. So you won't make that much more with the I Bond. Nevertheless, I Bonds have some nice features that CDs don't have such as being exempt from state and local income tax.
Series I Savings Bond Features
Below is a summary of the I Bond features. More information is available at this Treasury I Bond page:
- Can't be redeemed within 12 months of issue date
- Lose 3 months interest if redeemed within 5 years
- Interest is composed of fixed and inflation-based rate
- Fixed rate remains for life of bond
- Inflation-based rate changes every 6 months after issue date
- New rates announced every six months on November and May 1st
- Federal tax can be deferred on interest until bond is redeemed
- Interest is exempt from state and local tax
- Some or all interest is tax exempt when used for educational expenses
The current I Bond purchase limit is $10,000 per year ($5K online and $5K paper). However, starting in 2012, you will no longer be able to purchase paper I Bonds from banks and credit unions (see my post on this change).