The Labor Department released the September Consumer Price Index (CPI) numbers today, and with these numbers, the next Series I Savings Bond inflation component can be computed. This allows us to calculate the earnings for I Bonds purchased this month and redeemed from October 2016 to January 2017. Sometimes I Bonds compare favorably to 1-year CDs. That’s not the case this time due to the current I Bond rate of 0%. If you purchase an I Bond this month, you’ll earn 0% for the first six months. That 0% was the result of an I Bond inflation component of -1.6% last May. Inflation in the last six months has gone up. Today’s report showed that the CPI-U increased by 0.77% in the last six months. That’s an annualized rate of 1.54%. This should be the I Bond inflation component that will be announced at the start of November. Unfortunately, that’s not high enough to make I Bonds a good short-term deal. I’ll explain the details below.
Before I review the details of my I Bond rate calculations, today’s inflation report is also important for other reasons. Today’s inflation report is used by the Social Security Administration to determine the cost of living adjustment in 2016. Also, inflation is a major factor in the Fed’s decision on rates.
As seen in the CPI-U over the last six months, inflation did go up, but it didn’t offset the negative inflation seen at the start of the year. Over the last 12 months, the CPI was essentially unchanged. In fact, the inflation index used by the Social Security Administration was down 0.6% for the 12 months that ended in September (largely due to gas prices). Thus, for the first time in five years, there will be no annual raise in Social Security benefits.
The low inflation may also give the Fed reason to delay rate hikes. However, the Fed focuses on core inflation which excludes energy and food. This sometimes has caused the Fed to see low inflation when we are experiencing much higher inflation in the real world. Now the opposite is happening. Core CPI is showing more inflation than the CPI. While the CPI decreased 0.2% in September, core CPI increased 0.2%. Also, while the CPI essentially remained unchanged over the last 12 months, core CPI increased 1.9%. The core CPI increase in September was above the consensus forecast of a 0.1% increase. Thus, this inflation news may be good news for savers who are waiting for the Fed to increase rates. The news may not give the Fed a reason to delay rate hikes into 2016.
I Bond Rates
I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 1.54%. This is much higher than the current rate of -1.60%. 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%, and it probably won’t change much if at all in November. We won’t know the November fixed-rate until Monday November 2nd.
If you buy I Bonds before the end of October, you can know the rate you'll receive if you redeem the I Bonds between October 2016 and January 2017. The interest rate for the first 6 months will be based on the current inflation component (0%). The next 6 months will be based on this new rate (1.54%). After that, it'll depend on future inflation numbers. The current fixed rate component of 0% will stay the same for the life of the bond. Below are the details of calculating the expected rate of return.
I Bond Rates of Return for October 2015 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 2015 was 236.119. Last September 2015 CPI-U was 237.945. This is an increase of 0.77%. The annualized version of this is 1.54%.
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 -1.60%, and the composite rate is 0% (the composite rate floor is 0%). Here's an estimate of the return for the next year:
- 0% from October 2015 through March 2016
- 1.54% from April 2016 through September 2016
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 30, 2015, the value of the I Bond on October 1, 2016 would be about 0.39% higher. For 11 months, this comes out to an annualized yield of about 0.42%.
Below is an estimated annualized return for I Bond redemptions from October 1, 2016 to January 1, 2017. It is assumed you will buy the I Bond at the end of October 2015 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.
- 0.42% (11mo) redeem on 10/1/16, 6mo of 0%, 3mo of 1.54%, and 3mo of 0% (penalty)
- 0.52% (12mo) redeem on 11/1/16, 6mo of 0%, 4mo of 1.54%, and 3mo of 0% (penalty)
- 0.60% (13mo) redeem on 12/1/16, 6mo of 0%, 5mo of 1.54%, and 3mo of 0% (penalty)
- 0.66% (14mo) redeem on 01/1/17, 6mo of 0%, 6mo of 1.54%, and 3mo of 0% (penalty)
The highest guaranteed rate would be an annualized return of 0.66% for about 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 lower than 1-year CD rates that you can get from many internet banks. Even if you factor in the tax benefits of savings bonds, you’ll earn more with CDs, at least in the next 11 to 14 months.
To search 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.
One way to estimate future inflation rates is to use the historical average. Last year I calculated the average I Bond inflation rate since the I Bond program began in September 1998. That average was 2.57%. 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 I Bond inflation rate average 2.57% over the next 5 years, an I Bond purchased today will compare favorably to 5-year CDs purchased today. The best 5-year CD rate that’s nationally available is currently 2.45% APY at E-LOAN.
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.