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October I Bonds Will Outperform 1-Year CDs

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October I Bonds Will Outperform 1-Year CDs

The Labor Department released the September Consumer Price Index (CPI) numbers on Wednesday, and with these numbers, the next Series I Savings Bond inflation component can be computed. Higher inflation results in higher I Bond rates. As you might expect, inflation as reported by the government hasn’t been high. However, it’s high enough to still make the I Bond a good deal as compared to CDs. Of course the I Bond has a low annual purchase limit, so they can’t replace CDs for most savers.

This Reuters article provided a useful summary of the latest Labor Department release of the CPI data:

Inflation has waned in recent months after quickening in the second quarter, with a stronger dollar and slower economic growth in China and the euro zone dampening import prices. Sluggish wage growth has also helped keep a lid on prices.

I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 1.47%. This is down from the current rate of 1.84%. 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 0.1 percent, and it probably won’t change much if at all in November. We won’t know the November fixed-rate until Monday November 3rd.

If you buy I Bonds before the end of October, you can know the rate you'll receive for the next 12 months. The interest rate for the first 6 months will be based on the current inflation component (1.84%). The next 6 months will be based on this new rate (1.47%). After that, it'll depend on future inflation numbers. The current fixed rate component of 0.1 percent will stay the same for the life of the bond. Below are the details of calculating the expected return below.

I Bond Rates of Return for October 2014 Purchase

From Treasury Direct I Savings Bonds FAQs:

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 2014 was 236.293. Last September 2014 CPI-U was 238.031. This is an increase of 0.7356%. The annualized version of this is about 1.4712%.

If you buy before November, you'll receive the current I-Bond fixed rate of 0.1% 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 1.84%, and the composite rate is 1.94%. Here's an estimate of the return for the next year:

  • 1.94% from October 2014 through March 2015
  • 1.57% from April 2015 through September 2015

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 31, 2014, the value of the I Bond on October 1, 2015 would be about 1.36% higher. For 11 months, this comes out to an annualized yield of about 1.49%.

Below is an estimated annualized return for I Bond redemptions from October 1, 2015 to January 1, 2016. It is assumed you will buy the I Bond on October 31, 2014 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 1.49% (11mo) redeem on 10/1/15, 6mo of 1.94%, 3mo of 1.57%, and 3mo of 0% (penalty)
  • 1.49% (12mo) redeem on 11/1/15, 6mo of 1.94%, 4mo of 1.57%, and 3mo of 0% (penalty)
  • 1.50% (13mo) redeem on 12/1/15, 6mo of 1.94%, 5mo of 1.57%, and 3mo of 0% (penalty)
  • 1.50% (14mo) redeem on 01/1/16, 6mo of 1.94%, 6mo of 1.57%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 1.50% for about 13 or 14 months. Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. In 2011 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 short-term CD rate that you can get today. The best nationally available CD with a term of around one year is 1.30% APY for a 13-month term at USAlliance Credit Union. The table below provides a comparison between an I Bond held for 13 months and the best CDs with terms around one year:

Interest Rate Account Type Institution
1.50% APY ~13 months (10/31/14 to 12/1/15) I Savings Bond
1.30% APY 13-month CD USAlliance Credit Union
1.25% APY 12-month CD Citizens State Bank (FL)
1.21% APY 1-year Money Market Certificate Pentagon Federal Credit Union

These rates are accurate as of 10/25/2014.

To look for the best nationwide CD rates and the best CD rates in your state, please refer to our CD rates table.

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 2.57%. 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 much 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

Don’t forget that the annual purchase limit is $10K (excluding the purchases using your tax refund). Also, remember that the Treasury ended offering paper savings bonds at banks. However, it did double the annual purchase limit at Treasury Direct (see post).

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 (excluding purchases using your tax refund) - 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.

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Comments
Anonymous
Anonymous   |     |   Comment #1
What is the $ limit for tax refunds to be used to purchase I-bonds?
Anonymous
Anonymous   |     |   Comment #2
5,000 split at most for 3, i.e. the tax filer and two others--latter can have beneficiaries
Anonymous
Anonymous   |     |   Comment #3
the other advantage is no state tax on I bonds
Anonymous
Anonymous   |     |   Comment #4
Yes......No inflation here folks.......Move along......Nothing to see.......No inflation......Oops except energy, food, clothing, electronics, services,airlines,etc......No problem!!!!   All is well. Now do as your government tells you!
Anonymous
Anonymous   |     |   Comment #5
Well said.
Anonymous
Anonymous   |     |   Comment #6
A good place to park money...and generally forget about it.  Then, as Ken alludes to, redeem when rates go "up" (that is not a typo) without worrying what the "penalty" may be...always 3 months.   Clean and simple!
Anonymous
Anonymous   |     |   Comment #9
when rates go "up" 

I believe the word "up" is a typo.

No disrespect implied, Ken.  I just don't believe rates will ever go "up" significantly in our lifetime.
Anonymous
Anonymous   |     |   Comment #12
The $5000/y you call parked money, just to receive $75 in interest and to give it most of it back if you have better opportunity later on, no thanks from me.
Anonymous
Anonymous   |     |   Comment #13
With the ultra low fixed rate that they seem to always have, I think people should just quit buying them. 
Anonymous
Anonymous   |     |   Comment #14
And the alternative that offers an effective 1+ year rate that is the highest given low risk, no state tax, etc. Is?...You would suggest _____ where to park short term funds....did we miss that?.
Anonymous
Anonymous   |     |   Comment #15
Look for deals like the recent Navy FCU that paid 5% on a one year. 

Go longer and ladder.  Earn 3% instead of putting it all in 1 year maybe waiting for a long time to see interest rates go up.   If and when they do though, you will average in with a ladder program. 
Anonymous
Anonymous   |     |   Comment #16
The question was related to short term...i'm seeing nothing as an altrrnative to us bonds
henry
henry (anonymous)   |     |   Comment #10
where does it say 0% inflation? his article shows 2.5% average inflation since inception. THAT IS NOT ZERO!!!!
Anonymous
Anonymous   |     |   Comment #8
Ken

Your write up here is especially well done.  Thank you!
Anonymous
Anonymous   |     |   Comment #11
That is $10,000 in your name and $10,000 in your Wife's(Legal partner's) name for $20,000 a year if you wish.
hwhiteco
hwhiteco   |     |   Comment #18
It's actually $10,000 each, electronically from Treasury Direct...plus another $5000 each of paper bonds from your IRS refunds for a grand total of $30,000.  Naturally, you should ideally make the IRS overpayment as late as possible. Not sure, but filing for an extension, may even delay that time window even further.
Anonymous
Anonymous   |     |   Comment #19
Grand total $25k for joint returns...$30k if 2 separate returns
hwhiteco
hwhiteco   |     |   Comment #17
Should also mention purchases are dated the next business day. So if you did not purchase it by yesterday (10/30)...it's too late to obtain the higher I- Bond rate now.
Robert
Robert (anonymous)   |     |   Comment #20
http://www.treasurydirect.gov/news/pressroom/pressroom_comeeandi1114.htm Inflation rated confirmed at 1.48% (Ken, I think you had a rounding error when calculating 1.47%).  And the fixed rate is zero.  It was nice to have 0.2% and 0.1% fixed rates for the last year.  But for a $10,000 investment/year, it's not going to make that much difference.
Anonymous
Anonymous   |     |   Comment #21
Ken, with the release of the March CPI, any estimate on the new rate for IBonds for May?  Thanks
Anonymous
Anonymous   |     |   Comment #22
One estimate of new IBond rate for May 1st..."September 2014 CPI-U was 238.031. March 2015 CPI-U was 236.119, for a semi-annual decrease of 0.80%. Yikes! Deflation! ..."  But it cannot go lower than 0%.  Thus under this scenario unless the fixed portion moves the rate for May 1st for six months could be 0%.  Time to redeem?   See balance of article where quote is from   http://www.mymoneyblog.com/savings-i-bonds-may-2015-interest-rate-update.html