Which is better, CDs or I bonds?

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Today, while writing a story about the new savings bond rates released by the Treasury, I got to wondering, with CD rates at such ridiculous lows, have savings bonds, particularly I bonds, surpassed them as a savings vehicle?

After all, both are backed by the full faith and credit of the U.S. government, and the new I bond rate is 4.6 percent, reflecting a 2.3 percent increase in the Consumer Price Index in the preceding six months. Also, while the maturity of an I bond is 30 years, you don’t have to hold them that long if you don’t want to; they’re redeemable after five years, penalty-free. Sure, the core fixed-rate component of I bonds is still zero percent, but they’re still looking a whole heck of a lot better than five-year CD rates, which are currently averaging 1.71 percent.

I interviewed Greg McBride for the story, and he said that while that 4.6 percent annualized I bond return might look good at first blush, CDs have a couple of advantages over savings bonds that make them a much better investment overall.

First off, CDs can be laddered. All new I bonds have the exact same maturity: 30 years after the date of issuance. In contrast, CDs can be bought at varying lengths of maturity to allow you to roll them over and capture higher yields down the line.

CDs also offer the possibility of earning at least a little bit more than the rate of inflation, while I bonds are forever locked in to real return of zero.

Also key is that CDs don’t have any limit on the amount you can buy that can’t be overcome by simply opening a separate account at another institution. In contrast, the Treasury sets a $5,000 per year limit on the amount of both paper and electronic I bonds you can buy. Above a certain size portfolio, that limit curtails I bonds’ usefulness substantially.

Perhaps at some point, the Treasury will act to address some of these concerns by raising the I bond’s fixed component to provide some real returns for investors, or upping the limits on how much you can by, but McBride thinks that’s unlikely. As he says in the article, the long-term trend for I bonds doesn’t look good for seeing competitive fixed-rate components anytime soon.

Still, wouldn’t it be nice to have been one of the lucky ducks who bought I bonds when they first debuted in the late ’90s and early 2000s? If you had bought I bonds when their fixed-rate component peaked at 3.6 percent in May of 2000, you’d be sitting on risk-free bonds earning an annualized 8.2 percent return right now — not too shabby.

What do you think? Which is better, CDs or I bonds?