As expected, the new I-bond earnings rate for bonds purchased from May through October 2009 is 0 percent. The government's inflation-fighting bond is being issued with a fixed rate of 0.10 percent. But when that's combined with -5.56 percent annualized rate of inflation, the bond's earnings rate is set at zero because the U.S. Treasury guarantees that the bond won't have a negative accrual.
That's a huge drop from the 5.64 percent earnings rate that the November 2008 I bond had with its 0.70 percent fixed rate and adjustable rate of 4.92 percent.* That rate was due to the sharp rise in energy prices that occurred the previous six months. The opposite scenario -- the fall in energy prices over the past six months -- is why the current bond is netted out at zero.
This is a first for the I bond, which was first issued in September 1998, but it isn't the lowest fixed rate. The May 2008 I bond was issued with a 0 percent fixed rate, but since inflation was running at an annualized 2.42 percent, the bond had an earnings rate higher than zero.
The I bond's fixed rate stays with the bond for its 30-year life. The inflation component is adjusted every six months when a new bond is issued in May and November. Unless you think inflation will be running rampant for many years to come, it seems silly to lend your money to Uncle Sam for a questionable return.
William Larkin, fixed income portfolio manager at Cabot Money Management in Salem, Mass., suggests that consumers steer clear of the I bond.
"It's a retail product that's set up for individuals and it doesn't have a lot of liquidity. I do have a concern that inflation might not come. Americans may become more conservative, especially as the Boomers age because they're so far behind on retirement savings. Or, it could take a lot longer than we think for this recovery to happen and that could delay inflation for years. If you're holding Treasury Inflation Protected Securities you're holding something that's giving a below market rate."
Short-term bondsFor the time being, Larkin prefers short-term bonds, which you can buy in exchange-traded funds such as iShares' CSJ or Vanguard's BSV. The average maturity of these funds generally doesn't exceed three years. BSV's annualized 30-day yield currently is 2.44 percent; CSJ's is 4.81 percent.
Larkin says shorter securities, such as one-to-three-month T bills, will offer a good return once the Federal Reserve starts to change its monetary policy stance.
"When the recovery finally begins and the Fed raises its overnight lending rate, short T-bills will be the place to be if you're worried about inflation. It's a better mechanism because it will pick up the interest rate changes very fast -- but right now the yield is only about 0.20 percent."
Larkin suggests buying the T bills through the exchange-traded fund BIL.
"When we get ready to fight inflation this will go right into my personal arsenal. It saves me from having to roll the bonds all the time. I buy the fund, I can liquidate any time I want and it gives me a monthly payment."
Series EE bond, the other savings bond that's issued on the same schedule as the I bond, was issued with a fixed rate of 0.70 percent; down from the November 2008 rate of 1.30 percent. The bond has no inflation component but the Treasury guarantees that its value will, at a minimum, double within the first 20 years of maturity. If it doesn't, the Treasury makes a one-time adjustment to make up the difference.
I bonds and EE bonds are subject to federal income tax but are exempt from state and local income tax.
*The announced fixed and inflation components don't quite add up to the composite rate because of the way the composite is calculated.