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I bonds jump, Patriots slump
By Laura
Bruce • Bankrate.com
 The
I bond looks a whole lot better now that its composite rate shot
up to 4.66 percent. It had been pegged at 2.57 percent the previous
year.
Another popular savings bond,
the Series EE Patriot bond, saw its rate decline to 2.66 percent.
I bonds are government savings
bonds that are designed to make sure your return doesn't lose out
to inflation. Bonds purchased between now and the end of October
2003 will earn a fixed rate of 1.10 percent and an inflation premium
of 3.54 percent. I bonds are re-priced by the Treasury Department
every May 1 and Nov. 1.
But even though at first blush
it seems as though the new rate is a big improvement over the previous
rate, the drop in the fixed rate to 1.10 percent from 2 percent
is a concern.
"The reason it's significant
is the fixed rate stays with the bond for the life of the bond.
It's the spread you'll always get with the inflation component,"
says Dan Pederson, president of BondHelp.com and author of Savings
Bonds: When to Hold, When to Fold and Everything In-Between.
"The first three years
of the I bond's life, we saw fixed rates in the 3-percent to 3.6-percent
range. People who got those bonds are in a very good situation.
They retain those rates for the life of the bond. But in Nov. 2001
we saw the biggest drop in fixed rates, from 3 percent to 2 percent.
This 1.10 percent is a new low-water mark."
That's not a reason to hold
off on buying an I bond. The 4.66 composite rate is more than a
half percent better than the national average on five-year CDs,
and more than a couple points better than the national average on
one-year CDs.
The question, says Pederson,
is whether to cash the 1.10 percent bond six months -- or one year
-- from now if the new fixed rate rises. The government is extending
the minimum holding period from six months to one year effective
with bonds issued as of February 1, 2003.
"If you're a long-term
holder, there's a strong case for rebuying at the higher rate if
they bump it up down the road. If you have one at 1.10 percent and
it goes to 2.5 percent, I'd cash it in. The three months' interest
penalty would be insignificant compared to the gain."
You'll pay three months' interest
penalty if you cash an I bond in less than five years. You'll also
have to pay federal tax on the gain. I bonds are not subject to
state or local tax.
For more information, read
this story about how
I bonds work.
The other bond that is repriced
on the same six-month timetable as the I bond is the Series EE Patriot
bond. Its new interest rate is 2.66 percent, down from 3.25 percent.
The Patriot's interest rate
is 90 percent of the average yield of five-year Treasury notes for
the preceding six months. If you buy a Patriot between now and the
end of October 2003 you'll get 2.66 percent for six months from
the time you purchase the bond. After that you'll get the new rate
that is announced every six months in November and May.
Don't automatically assume
the I bond is a better investment than the Patriot just because
it has a higher rate for the next six months.
"The deceptive thing
about these numbers is it looks like the I bond is a better deal.
But over the past 12 years, the Patriot has averaged about 2.55
percent over inflation. So, if the Patriot holds to that trend then
it may, over the long haul, be the better buy," Pederson says.
Patriot bonds are bought at
one-half the face amount of the bond. In other words, you'll pay
$500 for a $1,000 bond. You receive the full face value if you hold
the bond until maturity. Bonds increase in value every month and
interest is compounded semiannually. Patriot bonds can be bought
in denominations ranging from $50 to $10,000.
Both I bonds and Patriots have a 30-year life.
You have to hold them for six months, or one year with bonds issued
as of February 1, 2003. As with the I bond, if you cash a Patriot
in less than five years, you'll forfeit three months' interest.
-- Updated: May 1, 2003
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