November I bond may be a toss of the dice
|By Laura Bruce Bankrate.com
With six months of Consumer Price Index data in the
hopper it's time to try to ascertain what rates the Treasury will
assign to the newest I-bond when it's issued Nov. 1.
One expert we spoke with estimates that the new combined rate will be 4.5 percent, up from the current combined rate of 2.4 percent. On the surface, it looks as though the new I-bond will blow away the current one. But the critical number for long-term investors is the fixed rate, and there's a decent chance that rate will be lower.
Dan Pederson, author of "Savings Bonds -- When to Hold, When to Fold, and Everything In-Between," says he expects the fixed rate to be left alone, but don't bet the farm on it.
"The inflation component will be about 3.1 percent.
If they leave the fixed at 1.4 percent you'd have a combined rate
of 4.5 percent. The only question is that 4.5 percent starts getting
into the range of attractive and whether they might trim it a bit.
I don't think they will, but had we not had the drop in the CPI
for September, the I bond would be up over 5 percent and there would
be a significant likelihood that they'd trim. But I could see them
cut the fixed rate to 1.2, and I wouldn't be really surprised to
see them cut it to 1 percent."
The I bond's combined rate is made up of two components,
a fixed rate that stays with the bond for its 30-year life and an
adjustable rate that's reset May 1 and Nov. 1, based on the rate
of inflation for the previous six months.
Buy now or wait?
The dilemma for those of you who may be considering buying the I
bond is whether to buy now, before the new rate is issued and know
exactly what fixed rate you'll get, or take a chance and wait.
Let's look at how the math works out. Buy now and get a fixed rate of 1.4 percent and an inflation rate of 1 percent for a combined 2.4 percent for the first six months that you own the bond. In April 2007, you'll get the inflation rate that's issued on Nov.1, 2006. If, as Pederson expects, it's 3.1 percent, you'll get a combined rate of 4.5 percent for the second six months that you hold the bond.
If you wait for the new issue, you will, presumably,
get the 3.1 percent inflation rate and, possibly, the same fixed
rate of 1.4 percent; but, as Pederson says, it wouldn't be surprising
to see the rate get trimmed. So, you could start out of the gate
with a combined 4.5 percent for the first six months, but if the
fixed rate is cut you'll fare worse as time goes on.
"If they wait and the fixed rate is lowered," says
Pederson, "they could lose 20 to 40 basis points on every year of
interest for as long as they hold the I bond."
A basis point is 0.01 percentage point.
Understand the adjustments
There's one final caution regarding I bonds. I bonds issued in October
2001 and before have a fixed rate of 3 percent or higher, and those
are the best I bonds out there. If we see an inflation component
of 3.1 percent, those bonds will be earning better than 6 percent
for the next six months. More specifically, no matter what the inflation
component is, those bonds will pay 3 percent or better above inflation
for the life of the bond. Pederson says some people get confused
when they see reports of the I-bond rate bouncing up and down and
they end up selling those bonds, perhaps because they don't really
understand how they work. Those bonds are keepers!