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Savings bond buyers may be offered a lousy deal

Beginning May 1, the U.S. Treasury started selling the Series EE savings bond at a fixed rate instead of the variable rate it previously offered.

The switch is good news for the Treasury, which will save money in a rising interest rate environment, but it might be bad news for savers.

Basically, it means bond purchasers will be locking in today's low rates for the next 20 years.

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Currently, the EE rate is, and will continue to be, adjusted every six months. With a variable rate, that meant that as interest rates went up, the Series EE rate went with it.

A change to a fixed rate means that the rate you get when you purchase will stay the same for the next 20 years. When rates are high, that's good news. But when rates are low by historical standards, as they are now, it's not such a great deal.

Of course, you can sell the bonds, but you'll pay a price. Both the Series EE and Series I bonds require investors to hold the investment for one year before it can be cashed. Even then, a penalty of three months' interest is assessed for any bond cashed within the first five years.

The new rate calculation does provide one premium. Until now, the rate has been based on the average of the five-year Treasury bill for the previous six months. With the change, it will be based on the 10-year Treasury average for the preceding month, which should be higher than the five-year Treasury rates.

"We'll look at a snapshot of the previous month," says Steve Meyerhardt, spokesman for the U.S. Bureau of Public Debt. "That tends to be more accurate the closer you get to the announcement."

The current rate for the five-year Treasury is 4.08 percent, while the current rate on the 10-year is 4.42 percent. Still, even after the Treasury does the averaging and further massages the rate to compensate for the lack of state and local taxes, it's not much of a premium for taking on the risk of locking in for 20 years.

It's clear the Treasury is making the change to save money in a rising rate environment.

"The Treasury sells approximately $3 billion in EE bonds each year," says Dan Pederson, president of the Savings Bond Informer, a bond consulting service. "Say they set it at 4 percent, and that's probably high, and they keep it flat for one year. If interest rates rise to 5 percent, that 1 percent difference translates into a savings of $30 million a year; $300 million in 10 years, and that's on just one year of bonds being offered at 4 percent. Every year you have another year of issues and savings."

But what's good for the Treasury, works against savings bond buyers. While interest rates have come off their historic lows, they still aren't worth locking in for five years, much less 20. Consumers know that. Treasury officials admit that sales this fiscal year are running behind last year.

"It's surprising, I'll say that," says Pederson of the change. "Treasury has spent 10 years touting the benefit of a market rate in terms of selling bonds. They've said the bonds didn't need a fixed rate because they track with five-year Treasuries, and that's more advantageous to consumers."

Advantage out, as they say in tennis.

Here's what bond buyers need to think about right now. If you buy the EE bond after May 1 you'll get the current fixed-rate of 3.5 percent for the next 20 years. The fixed rates are pegged to the 10-year Treasury and will be reset every May 1 and Nov. 1 for bonds purchased after those dates.

Just as with the current bond, the Treasury guarantees that you'll double your money in 20 years. That means the new bond rate has to be at least 3.5 percent; if it's below that the Treasury will make up the difference.

While you will double your money -- if you hold the bond for 20 years -- how likely is it that your investment will keep up with inflation? It seems that in a rising rate environment the best thing to do is opt for the current bond or hold off on purchasing one of the new bonds until rates rise significantly.

-- Updated: May 4, 2005




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