savings

Is there a higher yield for savings?

Don TaylorQuestionDear Dr. Don,
Every month, I deposit $100 into my TreasuryDirect account through payroll deduction.  In the past, I was set on purchasing Series EE bonds every month as a way to save for future expenses. However, with such low interest rates on EE bonds, how can I better spend my $100? Would I be better off buying Treasury bills, notes, or TIPS? Or should I buy nothing at all and invest somewhere else?
-- Paul Payroll

AnswerDear Paul,
A timely question, as the Treasury phased out the issuance of paper savings bonds through payroll deduction for all employees on January 1, 2011. The payroll deduction plan still exists; the Treasury is just requiring participants to hold the bonds electronically in a TreasuryDirect account. You can learn more about the changeover on the TreasuryDirect Web page, "Frequently Asked Questions About the Elimination of Paper Payroll Savings Bonds."

In my opinion, the Series EE savings bond has been a poor choice for savings since May 1, 2008. Series EE savings bonds started paying a fixed rate in May of 2005. Series EE bonds issue-dated May 1, 2005 and after earn a fixed rate of interest. This fixed rate is determined by the issue date of the bond. A new fixed rate is announced every Nov. 1 and May 1. The table below, adapted from the TreasuryDirect website, shows the fixed rates announced since May 2005.

Fixed rates for Series EE bonds
DateSeries EE Savings Bond Rates
Nov 2010 - Apr 20110.60%
May 2010 - Oct 20101.40%
Nov 2009 - Apr 20101.20%
May 2009 - Oct 20090.70%
Nov 2008 - Apr 20091.30%
May 2008 - Oct 20081.40%
Nov 2007 - Apr 20083.00%
May 2007 - Oct 20073.40%
Nov 2006 - Apr 20073.60%
May 2006 - Oct 20063.70%
Nov 2005 - Apr 20063.20%
May 2005 - Oct 20053.50%
Source: TreasuryDirect (http://www.treasurydirect.gov/)

A Series EE bond bought between Nov. 1, 2010 and April 30, 2011 earns a low fixed rate of .60 percent. Series EE savings bonds, however, are required by law to double in value in 20 years. Hold the bonds for 20 years and you'll earn about 3 ½ percent. Redeem the bonds before they're 20 years old and you leave that additional interest on the table and just earn the lower fixed rate. Hold them past 20 years and, unless the government decides to modify the interest rate, they go back to earning the fixed rate announced at issuance. The table below shows the stark contrast between cashing in a $25 savings bond after 19 ½ years and after 20 years:

Value of Series EE bond owned
for 20 years versus 19 1/2
Years OwnedInterest RateBond Value
19 ½0.60%$ 28.10
203.50%$ 50.00

To me, it's an easy choice between the Series I and Series EE. Pick the Series I. The interest earnings on the Series I come from two sources: a fixed yield based on when you bought the bond, and a variable yield based on the inflation rate as measured by the consumer price index (CPI). The variable rate changes every six months. At this writing, a newly purchased Series I has a combined yield of .74 percent versus the .60 percent of the Series EE.

The fixed yield on the Series I is 0.00 percent, so all the interest earnings are coming from the yield on the inflation component. Inflation has been pretty tame over the last two years, but over the next 20, my expectation is that you'll earn more on the Series I than the Series EE over time, even with the Series EE yielding 3 ½ percent on its 20 th birthday. If you think inflation won't average over 3 ½ percent annually over the next 20 years, and you plan to hold the bonds for at least 20 years, then don't buy this Series I savings bond.

With interest rates backing up over the past few weeks, the longer-term treasury securities have gotten a lot more interesting, but the concern is that rates are headed even higher. That's okay; you're dollar cost averaging your investment over time versus investing a lump sum today. You can buy treasury securities in a TreasuryDirect account in minimum denominations of $100 and still do it with payroll savings, as described on the TreasuryDirect web page "Payroll Savings," and presented below:

Your payroll deduction can be used in your TreasuryDirect account to buy more than just savings bonds.

With TreasuryDirect's convenient payroll direct deposit, choose the amount you want to withhold. The money will be deposited in your Certificate of Indebtedness (C of I) in your TreasuryDirect account. The funds in your C of I can be used to purchase your choice of electronic Treasury securities including:

  • Treasury Bills
  • Treasury Notes
  • Treasury Bonds
  • Series EE and I Savings Bonds
  • Inflation-Protected Securities (TIPS)

I like the TIPS for their inflation protection. Like the Series I savings bonds, the TIPS pay a fixed coupon plus an inflation yield, but there are tax considerations in owning TIPS that you need to understand, namely that you pay income tax on the inflation yield in the year earned, but don't realize the inflation yield until you redeem the bond or it matures. Series I savings bonds, and Series EE for that matter, let you defer paying income taxes on the interest earnings until the bonds are redeemed or mature. Talk to your tax professional if you don't understand the tax issues surrounding these investments.

As for investing somewhere else, you've only shown me this one small slice of your portfolio. I know you're investing $100 each month in savings bonds. I don't know the big picture. How close are you to retirement? Do you have a pension? What retirement accounts are you funding? How are they invested? Bring in a big-picture person to review your finances if you want to expand your investment horizons. The Bankrate feature, "Financial planners: Not just for millionaires anymore," can help you with that step. Good luck.

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