The Labor Department released the March CPI numbers today, and with these numbers, the next I Bond inflation component can be computed. Thanks to the recent inflation, it's a very high 4.60%. This number is added on to the I Bond fixed rate to derive the I Bond composite rate.
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 April, 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 (0.74%). The next 6 months will be based on this new rate (4.60%). After that, it'll depend on future inflation numbers. The current fixed component of zero percent will stay the same for the life of the bond. I describe the details of calculating the expected return below.
If you decide to wait after April to buy I Bonds, you'll have to guess about the May fixed rate component. At least we know it can't drop below zero percent (at least by the current rules at the Treasury). Based on today's rate environment, I think it's very likely to stay zero percent. Based on this we can easily compute the short-term rate of return, but first, I'll compute the rates of return if the I Bond is purchased before May.
I Bond Rates of Return for April 2011 Purchase
The semiannual inflation rate announced in May is the change between the CPI-U figures from the preceding September and March
All previous CPI-U numbers are available from this government webpage. The CPI-U for September 2010 was 218.439. Last March 2011 CPI-U was 223.467. This is an increase of 2.301%. The annualized version of this is about 4.60%.
If you buy before May, 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 0.74%, and the composite rate is 0.74%. Here's an estimate of the return for the next year:
- 0.74% from April 2011 through September 2011
- 4.60% from October 2011 through March 2012
I Bonds increase in value on the first day of the month. So on May 1st, you'll earn the interest for the full month of April. 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 April 29, 2011, the value of the I Bond on April 1, 2012 would be about 1.53% higher. For 11 months, this comes out to an annualized yield of about 1.66%.
Below is an estimated annualized return for I Bond redemptions from April 1, 2012 to July 1, 2012. It is assumed you will buy the I Bond on April 29, 2011 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.
- 1.66% - redeem on 4/1/12, 6mo of 0.74%, 3mo of 4.60%, and 3mo of 0% (penalty)
- 1.90% - redeem on 5/1/12, 6mo of 0.74%, 4mo of 4.60%, and 3mo of 0% (penalty)
- 2.11% - redeem on 6/1/12, 6mo of 0.74%, 5mo of 4.60%, and 3mo of 0% (penalty)
- 2.29% - redeem on 7/1/12, 6mo of 0.74%, 6mo of 4.60%, and 3mo of 0% (penalty)
The highest guaranteed rate would be an annualized return of 2.29% for about 14 months (from 4/29/11 to 7/1/12). Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. You probably want to give yourself a few days to ensure they are officially purchased before the end of the month.
I Bond Rates of Return for May 2011 Purchase
As I mentioned above, we won't know the I Bond fixed rate until May. However, it's very likely to remain zero percent. So the worst case composite rate will be 4.60%. If inflation stops rising in the next several months, and the November 2011 I Bond inflation component is zero percent, the rate of return is easy to calculate. It will be half of 4.60% (4.60% for 6 months and 0% for 6 months). And in that case the 3 month penalty is also zero. So the total rate of return is 2.30%. If you buy the I Bond at the end of May 2011 and redeem the I Bond at the start of May 2012, the time period is close to 11 months. Thus, the annualized rate of return becomes 2.51%. We can also estimate the annualized return for I Bond redemptions for June, July and August. The following assumes the I Bond will be purchased on May 31, 2011. As I mentioned above, this effectively reduces the 3-month penalty to 2 months.
- 2.51% - redeem on 5/1/12, 6mo of 4.60%, 3mo of 0.00%, and 3mo of 0% (penalty)
- 2.30% - redeem on 6/1/12, 6mo of 4.60%, 4mo of 0.00%, and 3mo of 0% (penalty)
- 2.12% - redeem on 7/1/12, 6mo of 4.60%, 5mo of 0.00%, and 3mo of 0% (penalty)
- 1.97% - redeem on 8/1/12, 6mo of 4.60%, 6mo of 0.00%, and 3mo of 0% (penalty)
So if you're going to wait until May, a 2.51% APY for 11 months is probably the best you can do. Each month you wait, the period of zero percent increases. Going out any further requires an estimate for the inflation component in May 2012 in addition to November 2011.
What if the I Bond inflation component in November 2011 is 2.00%? This seems like a reasonable estimate. Recalculating the above with all other assumptions the same results in the following:
- 3.05% - redeem on 5/1/12, 6mo of 4.60%, 3mo of 2.00%, and 3mo of 0% (penalty)
- 2.97% - redeem on 6/1/12, 6mo of 4.60%, 4mo of 2.00%, and 3mo of 0% (penalty)
- 2.89% - redeem on 7/1/12, 6mo of 4.60%, 5mo of 2.00%, and 3mo of 0% (penalty)
- 2.83% - redeem on 8/1/12, 6mo of 4.60%, 6mo of 2.00%, and 3mo of 0% (penalty)
So if you buy an I Bond on May 31, 2011 and you redeem that I Bond on May 1, 2012, your annualized yield for 11 months will be at least 2.51%, and it could easily be 3.05%.
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 2.51% APY for 11 months on $10K, the total dollar amount of interest is about $230. For 3.05% APY it'll be about $280. As a comparison, a $10K deposit into Ally Bank's No-Penalty CD (at 1.15% APY) would return about $105. 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.
I 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
- $10,000 maximum of I Bond purchases per year ($5K online and $5K paper) - total was $60,000 before 2008 (Treasury's press release).
For more details about the purchase limit, please refer to the Treasury Direct's FAQ on the new purchase limit.