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Predicting the I Bond Fixed Rate


If you want to use I Bonds as a short term investment, now is the time to purchase them (see previous post). If you buy them before the end of the month and redeem them early in January 2007, you'll get an annual return that's close to 5%. And this interest is free of state and local taxes. So if you live in a state with a 10% tax rate, this 5% return is equivalent to a 5.8% CD. That's 1.2% over the highest 1-year CD that's nationally available.

However, if you're thinking more long term, you may want to wait until November. Long term I Bond investors are more concerned with the fixed rate component of an I Bond. The fixed rate stays constant as long as you own the bond (up to 30 years). The inflation-rate component is added on and changes every 6 months. Currently, the fixed rate is 1.2%. Back in 2000 it had been as high as 3.6%. If the fixed rate is going to rise in November, it would be better to wait. If it's going to go down, it would be better to buy now.

Fixed Rate Predictions - What the Experts Say

Dan Pederson, author of "Savings Bonds: When to Hold, When to Fold and Everything In-Between," estimates the fixed rated coming in somewhere between 0.5% and 1%. His theory is that with the inflation component so high there's no need to pay over 6% to attract investors. You can read more about his interviews at philly.com and at Bankrate.com.

Another savings bonds expert disagrees. Tom Adams, author of "Savings Bonds Alert" believes that the fixed rates are based on the equivalent market rates for Treasury Inflation Protected Securities (TIPS). He calls TIPS the big-boy version of I Bonds. Since that rate has been going up recently, he predicts the fixed rate for the I Bonds to also increase. His best guess is between 1.30% and 1.50%. More information is available at his blog.

Fixed Rate Predictions - What History Says

I think you can get a clue about November's fixed rate based on the history of the I Bonds rates and the Federal Reserve Board's Funds rate. I Bonds fixed rates have generally followed the Fed funds rate.

Some history that contradicts Pederson happened in May 2000 when the I Bond rate increased from 3.40% to 3.60%. The inflation component also increased from 3.52% to 3.82% giving a combined yield of around 7.4%. If the Treasury was only thinking about keeping the rate competitive, I don't think they would have raised it. Even though CD rates were much higher back then, the inflation component had gone up to its highest rate since the I Bond inception. The higher fixed rate wasn't necessary.

The change that occurred in May 2002 also contradicts Pederson. In that case the inflation component fell to a very low 0.56%. The fixed rate remained at 2.00% giving a combined rate of around 2.6%. This was now much lower than other comparable investments like 5-year CDs. If they wanted to keep I Bonds competitive, wouldn't they have increased the fixed rate by at least a little?

My Prediction

So after reviewing the opinions from the experts and looking back at history, I'm in the Adams camp. My prediction is for a 0.20% increase in the I Bond fixed rate.

How to Buy?

If you're interested in purchasing I Bonds, you have two choices. You can buy the paper versions at most banks. You can also buy the electronic versions online at TreasuryDirect.gov. The most you can buy in one calendar year is $60K ($30K in paper and $30K online).

I recommend using TreasuryDirect. The process is just like opening an account with an online bank. When you open an account, you link it with a checking account, and it's used to fund the purchase.
Phil   |     |   Comment #1
I added your name to the prediction list at Morningstar. The thread listed below takes a while to get to specific predictions, but near the end of the thread there are predictions.

I-Bond fixed rate predictions
Banking Guy
Banking Guy   |     |   Comment #2
Thanks! I was lucky when I predicted a 0.2% rise before last May. See if my luck continues this time.