Sunday, November 6, 2011

Tired of earning 0% interest? Try I bonds.

With interest rates at record lows, I’m sure many people out there have noticed that it’s been a bit difficult to earn any money on what you have sitting in the bank. A quick glance at my savings account at America First shows that it’s been yielding a paltry 0.15%. More sophisticated (yet still safe) investments such as CDs, money market accounts, or money market mutual funds have also provided little help to those wanting to have their money make their own money. And that is the point of the blog—to have you one day be able to live from money made by your other money. The big problem currently is the fact that, while we’re earning little to no interest, inflation hasn’t been flat. In fact, over the last six months inflation has been running at a ~3% annualized rate. So what is one to do?

You may be surprised to hear that the answer to such a conundrum comes in a little-appreciated tool called an I Bond (or, officially, a Series I Savings Bond). The current return on these risk-free bonds is a healthy 3.06%. Yup, those hum-drum savings vehicles from yesteryear may make a sophisticated play indeed. The main benefit of these bonds is that they track inflation (I is for inflation), while providing safety (they’re backed up by the federal government) and tax-deferred growth. The return is composed of a fixed rate (currently 0%, but changed every 6 months) and an inflation component (currently the 3.06%), which is calculated from the consumer price index over a recent 6 month period. So I bonds bought after November 1st receive the inflation rate as calculated from March through September.

The bonds can be held for up to 30 years, during which the fixed rate will stay the same (currently 0%), but every 6 months the inflation rate will adjust to whatever consumer prices (aka, the CPI-U) have been doing. One of the only catches is that you cannot redeem the bond for at least one year, and if you redeem it within 5 years you lose the last 3 months’ interest. But that’s not a huge deal. You’ll notice it’s very similar to a CD, but the rate is currently much better. You can either buy these things from your local bank or online at treasurydirect.gov (there’s a yearly limit of $5000 per each method). While money for retirement would be better placed in stocks and other types of bonds (hopefully in a Roth), I bonds provide a great way to save money that you may need in a few years.

I bonds in a nutshell:

· Are flexible.

· Are risk-free.

· Offer inflation protection.

· Are tax-deferred (or tax-free from state and local taxes).

· Provide a great way to save for your kids’ tuition.

If you’re tired of earning nothing at your bank, check ‘em out. For more info, check out a great four part I bonds series by the bogleheads on Forbes.com here, here, here, and here. Another basic article, which was excited about the 4.6% rate offered earlier in the year, is here.

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