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Comparing CDs and savings bonds

Dr. Don Taylor

Dear Dr. Don,
Are CDs (certificates of deposit) a better investment than Series EE or Series I savings bonds?
Janet Judicious

Dear Janet,
It depends. What's your investment horizon and how likely is it that you'll need to redeem the investment prior to maturity? Your investment horizon is an estimate of when you plan to need the money and the probability of early redemption deals with the possibility that you'll need the money sooner than you planned. Both savings bonds and CDs have early redemption penalties, and you now have to own a savings bond for at least one year before you can redeem it. Your investment horizon and possible redemption needs are very important when deciding how to invest.

The Bureau of Public Debt's Web site explains the interest rates on Series EE and Series I savings bonds:

Series EE savings bonds are now a fixed-rate bond with its new rate based on the 10-year Treasury average for the preceding month with adjustments made for features such as tax deferral. When you buy the EE bond, you'll earn the current fixed-rate for the next 20 years.

It had previously earned 90 percent of the average yields on five-year Treasury securities for the six months preceding the announcement of new rates. While the Treasury Department will still announce new rates each May 1 and November 1, the new interest rate will apply to Series EE savings bonds purchased after those dates.

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Currently, Series EE bonds earn 3.5 percent.

Series I savings bonds have both a fixed interest rate component that is established at the time you purchase the savings bond and a variable interest component that changes every six months based on changes in the Consumer Price Index (CPI). The current interest rate on Series I bonds is 4.8 percent. The compound rate includes a fixed rate of 1.2 percent and a semiannual inflation-adjusted rate of 3.58 percent. (The slight discrepancy is due to the way the composite is calculated.) The rates are reset every May 1 and November 1.

If you're saving for your children's college education, then investing in savings bonds can make more sense because of the Savings Bonds for Education program. There are income restrictions, so review the rules before starting this program.

Both CDs and savings bonds, like U.S. Treasury securities, have no risk to principal, although a Treasury security can sell at a loss if sold before it matures. Assuming a five-year horizon, the alternatives are shown below:

Investment Options Yield
Series EE Savings Bond 3.5%
Series I Savings Bond 4.8%
5-year CD 4.22%*
5-year Treasury Note 3.91%

The yields on the Series I savings bonds will fluctuate with the interest rate resets in November and May each year. If you think inflation will heat up over time and/or interest rates will head higher, then the savings bonds will capture some of that trend.

The longer your investment horizon, the more attractive the savings bonds become vs. CDs because of the variable interest rates and early redemption options.

-- Updated: May 5, 2005


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