Guest Author - Reshma Vyas
The ongoing financial crisis, stock market turmoil, the slump and uncertainty surrounding the housing sector and the collapse of major seemingly stalwart banks has millions of individual investors scurrying for “safe” investing havens. Safety of principal rather than the pursuit of higher yield has become the guiding focus for many individuals today. Traditional places for hoarding cash such as banks which were once regarded as stodgy but safe places are being more closely scrutinized by many individuals in light of recent banking failures and subsequent economic pressures within the credit markets. Are there any options other than bank certificate of deposits and savings accounts? While “safety” is a relative term; no investment is ever truly guaranteed, not even a “low-risk” one; one investment that is garnering considerable attention is U.S. Savings Bonds.
Many individuals concerned with safety of principal are taking a fresh look at U.S. savings bonds which for many years, especially during the go-go period of the 1990s, were often dismissed in a condescending manner by a significant number of investors and professional money managers as “ordinary” low-yielding investments not even worth discussing in the same vein as other “serious” investments such as mutual funds. Savings bonds lacked the glamour and high-growth potential (and of course, the volatility) of exchange traded funds or hedge funds. Now some of those same investors and money managers are flocking to U.S. Savings Bonds. What are some of the benefits of U.S. Savings Bonds?
1. “Safe” in that they are issued and backed by the full faith and credit of the United States government. Special note: they are not insured such as bank certificate of deposits which are FDIC insured.
2. Exempt from local and state taxes; unlike interest earned from bank certificates of deposit and savings accounts which are taxed as ordinary income. Savings bonds are subject to federal taxes, however.
3. Can be purchased through TreasuryDirect.
4. The SmartExchange option available through TreasuryDirect enables investors to convert paper Series E, EE and I bonds to electronic bonds.
There are two types of savings bonds that are of primary interest to individual investors: Series EE and Series I bonds. It is worth noting that the interest on Series EE and I bonds is compounded semi-annually for 30 years.
Series EE bonds, if they were purchased on or after May 1, 2005, earn a fixed-rate of interest which is of great help to investors in figuring out the value of their bonds. Series EE bonds can be purchased electronically or in paper form. Electronic EE bonds are sold at face value and can be purchased from TreasuryDirect whereas paper Series EE bonds are sold at half their face value. The maximum purchase allowed for either electronic or paper Series EE bonds is $5000 in a calendar year. Special note: paper EE bonds are sold in predetermined amounts: $50, $75, $100, $200, $500, $1000, $5000 and $10,000.
The Series I bond is based on two types of rates: a fixed rate and the rate of inflation. The “I” in the Series I bond stands for inflation as the bond is tied to a benchmark; in this case, the rate of inflation. The goal of Series I bonds is to keep pace with the rate of inflation. You can purchase paper Series I bonds in paper or electronic form. Paper I bonds are sold in denominations of $50, $75, $100, $200, $500, $1000, $5000. Key point: the Series I is sold at face value and pays a fixed-rate of interest as well as a semi-annual inflation rate that is variable. The semi-inflation rate is announced twice a year by the Public Bureau of Debt: May 1 and November 1. It is based on the CPI-U (Consumer Price Index for all urban consumers).
Is there a downside to investing in savings bonds?
Lack of liquidity is a major drawback for investors who need access to liquid funds. Savings bonds, whether Series EE or I, have the same restrictions. Individuals must wait a minimum of one year before redeeming the bond and if the bond is redeemed before 5 years, they will lose interest on the most recent 3 months. If the bond is redeemed after 5 years, investors will not incur a penalty.