I bond's critical fixed rate may drop
By Laura Bruce • Bankrate.com

The government's inflation-fighting savings bond, the I-bond, currently sports a composite rate of 3.74 percent. The new rate, which will be announced Nov.1, may be higher, but the all-important fixed-rate component could fall, and that would make it a bad buy.

The current composite rate of 3.74 percent is composed of a fixed rate of 1.3 percent, which stays with the bond for its 30-year life, and a semiannually adjusted inflation rate of 2.42 percent. (The slight discrepancy is due to the way the composite is calculated.) The new fixed rates and the semi-annual adjustments are announced every Nov. 1 and May 1. In pricing the I bond, the Treasury looks at the previous six months of inflation data based on the Consumer Price Index for All Urban Consumers, or CPI-U.

Based on the latest inflation data, savings bond expert Dan Pederson, author of "Savings Bonds: When to Hold, When to Fold, and Everything In-Between," says that with an annual inflation factor of just under 3 percent, he expects the Treasury will freeze or decrease the fixed rate by up to 20 basis points, raise the adjustable inflation rate and come out with a composite rate of approximately 4.3 percent.

That may look like a significantly better deal than the current bond, but if the fixed rate is cut, the long-term picture for the bond issued Nov. 1 is poor.

Focus on fixed rate
"If people are looking at the I bond, I believe their attention should absolutely be on the fixed rate and not on the variable rate," says Pederson. "With my prediction of no chance of the fixed rate increasing and a slight chance of it decreasing 10 (basis points) to 20 basis points, I'd be looking to buy before Nov. 1, not after. Even though your initial rate would be only 3.74 percent, the important thing is you're locking in the 1.3 percent fixed rate."

But even that 1.3 percent is paltry. Pederson says there's really no reason for the Treasury to pay a premium on the I bond over their other products. In the early days of the I bond, the fixed rate was often above 3 percent, but that, Pederson says, was an attempt to get the I bond established in the marketplace.

Better deals to be had
Even if the new composite rate is 4.3 percent, there may be better deals available. As of this writing, there are more than a half-dozen one-year CDs sporting at least a 5 percent yield in Bankrate's high-yield database. You'd have to do some math because I bonds are exempt from state and local taxes, and federal taxes can be deferred until redemption, but high-yield alternatives should be explored.

The series EE savings bond also is re-priced semiannually. The EE is a fixed-rate bond that currently pays 3.4 percent annually. Pederson expects there could be a drop, probably not more than 10 basis points or 20 basis points, that would bring it in between 3.2 percent and 3.4 percent. The bond is pegged to some degree on the 10-year Treasury note, but other factors are considered that allow the Treasury to set it somewhat arbitrarily.

For more on the I bond, visit Bankrate's Investing Basics.