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New I-bond rate rises

I bonds issued from November 2007 through April 2008 will earn an annual rate of 4.28* percent, according the U.S. Treasury. That's better than a half percent higher than the previous rate of 3.74 percent, but in the long run the bond isn't a better deal.

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The I bond is a savings bond with a variable-rate component that's meant to offset inflation. The inflation component for the current bond is 3.06 percent; which is 64 basis points above the previous inflation component of 2.42 percent. The inflation rate changes every six months when the bond is repriced on Nov. 1 and May 1.

But the bond also has a fixed-rate component that stays with the bond for its 30-year life, and the current fixed rate is 1.2 percent; 10 basis points lower than the previous fixed rate. Experts say that a investor's attention should be focused solely on the fixed rate when considering this bond as an investment.

High-yield alternatives
A fixed rate of 1.2 percent is not a good deal for consumers when there are high-yield alternatives available. The I bond can't be sold for one year, and if you sell it in less than five years there's a penalty of three months' interest.

William Larkin, fixed-income portfolio manager at Cabot Money Management Inc. in Salem, Mass., recommends the iShares exchange-traded TIPS bond fund (NYSE: TIP), which invests in inflation-protected Treasury bonds. It currently yields 3.74 percent but has a year-to-date return of 6.2 percent.

"You have the ability to collect monthly income and trade it any time you want, and that's important today," says Larkin. "Events in people's lives change and the function is the same, so why not have something that offers you a little bit better conditions as an investor?"

TIP shares are currently around $103. Larkin says any price under $100 is fair value, so wait for a pullback.

Larkin also recommends Vanguard's Long-Term Investment-Grade Corporate Bond fund (VWESX) and Vanguard's Long-Term Bond exchange-traded fund (BLV).

Other options include high-yield certificates of deposit, many of which are still yielding more than 5 percent. And high-yield savings and money market accounts are also paying better than 5 percent.

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

Unpopular EE bonds
The other savings bond that is repriced semi-annually is the Series EE bond. The EE only has a fixed rate and it applies for the life of the bond. The current rate is 3 percent, down from the previous rate of 3.4 percent. Dan Pederson, author of "Savings Bonds: When to Hold, When to Fold, and Everything In-Between," said he thought the EE would drop because Treasury rates have been dropping, but the drop was bigger than expected.

"Forty basis points represents about a 12 percent drop in the interest rate and it makes it even less attractive," says Pederson. "It already wasn't winning any hearts, but it's now even less palatable than it was before."

I bonds' and EE bonds' interest earnings are subject to federal income tax but are exempt from state and local income tax.

Bankrate.com's corrections policy
-- Posted: Nov. 2, 2007
 
 
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