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Savings-Bonds-Alert: San Francisco Chronicle reports on Series EE fixed rates

Thursday, April 07, 2005

San Francisco Chronicle reports on Series EE fixed rates

This week San Francisco Chronicle financial columnist Kathleen Pender published a very good article on the upcoming change to Series EE fixed-rate Savings Bonds, Savings Bond revamp. I don't say it's good just because she quoted me (smile), but I should point out that I may be a bit biased. She also quotes Dan Pederson of the Savings Bond Informer and actually highlights our differing views on the Series EE versus Series I question. Pederson has been quoted for years saying that over the long term, the adjustable Series EE bond rate has averaged about 2 per cent over the inflation rate. Consequently, he has said, when the Series I fixed rate was under 2 per cent, the adjustable-rate EE bonds were the better choice. When the I bond fixed rate was over 2 per cent, his analysis was that I bonds were preferable. I agree with Pederson that his 2 per cent over inflation analysis is correct, but I don't think it's detailed enough. As I explain in my book, a graph of inflation and interest rates over the last 50 years looks like a pyramid, with the peak in the early 80s. As inflation and interest rates climbed that peak, inflation led the way. During that part of the cycle, EE bonds paid only about one-third of a percent more than the inflation rate. As inflation and interest rates fell from the peak, inflation continued to lead the way. During that part of the cycle, EE bonds averaged about 3-1/3 per cent more than the inflation rate. So, yes, the average rate Series EE bonds would have paid over the whole 50 years is about 2 per cent more than inflation. (Note that the current rate-setting rules weren't actually in effect during that whole period, but we can still calculate what the rates would have been under the current rules for the entire period.) But when we tease apart what happens when we're in the part of the cycle where rates are headed up, it's clear that even I bonds with a measly 1 per cent fixed base rate will earn more than Series EE in that part of the cycle. So if you agree that our huge government and trading deficits imply that we've once again started up the high-inflation, high-interest part of the curve, Series I bonds are clearly the better choice. Although the Pederson-Adams controversy may seem like a moot point now that the Treasury has changed the rules for Series EE, I don't think it is. My point is that from an investor's point of view, Series I bonds were the better choice when interest rates were going up anyhow. So the change doesn't cost investors anything in that part of the curve. And after rates peak and begin heading down, the ability to lock in high rates with Series EE will give investors the opportunity to earn far more than 3-1/3 per cent more than inflation. Rather than seeing their rates adjust downward, as they would under current Series EE rules, the new rules will provide the ability to lock in those high rates for 30 years. Fixed rate Series EE bonds are great news for investors - just not right now. Keep buying those Series I bonds for now. The new Series EE bonds will be preferable some years down the road, when interest rates peak.

1 Comments:

Blogger IIbonds said...

"And after rates peak and begin heading down, the ability to lock in high rates with Series EE will give investors the opportunity to earn far more than 3-1/3 per cent more than inflation. "

Most likely the next big inflation push similar to the 70s will not end so nicely as the early 80s. It will likely end with hyper-inflation that will destroy the perceived value of our Fiat Dollars.
In the off chance that does not happen, the best thing about the new EE fixed rate bonds is that smart fellows can wait till close to the end of the 6 month rate adjustment to make purchases if long-term rates have fallen significantly.
For example if the EE rate fixed on May 1st is 10% then by October the 10-year T-Note rate drops to 8%, one would be wise to run out and buy the EE bonds sporting a 10% rate before November 1st.
These EE bonds are a superior alternative to regular long-term bonds for small investors since the principal will not drop as LT rates rise. Allowing you to redeem them for new ones. A nice feature even after taking into account the 1 year redemption restriction and the 5 year 90 day interest penatly.

P.S. People should be cautious in making the naive assumption that the CPI rate used in I-bonds calculations is an accurate depiction of "inflation". In fact recently the CPI indices have clearly understated inflation, and this trend will likely continue and get worse.
As with anything, BUYER BEWARE, do your research and use your brain.

4/12/2005 12:37:00 PM  

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