Wednesday, April 16, 2008

Treasury I-Bond rate could approach 6% in May

One inflation hedge is the U.S. Treasury I-Bond which pays a nominal fixed rate plus inflation. The I-Bond rate is reset every six months and that rate is in effect for the next six months. Rate resets occur on May 1 and November 1. For I bonds purchased in the November 1007 through April 2007 period the rate has been 4.28%. The rate for May has not been set yet, but since inflation was just reported today for March, we can estimate that semiannual inflation was 2.42%. We do not know what Treasury will do with the nominal fixed rate for May, but if it was kept at the current 1.20%, the I-Bond rate would work out to 6.07%. If the fixed rate were dropped to 1.00%, the I-Bond rate would still be 5.87%. Not bad. But this rate would only be good for six months before it resets again based on inflation over the next six months.

I-Bonds are a great investment if you expect inflation to be high and you do not need access to your cash for a few years. But if inflation falls, your I-Bond yield will fall as well.

Here is another twist: The fixed rate is set when an I-Bond is issued and does not reset every six months. So, if you buy now, you can lock in the current fixed rate of 1.20%. The downside is that you won't get a higher fixed rate if the fixed rate rises in the future. Check this out: If you had purchased an I-Bond in May to November of 2000, when the fixed rate was 3.60%, you would currently be earning 6.72% and in May your rate would jump to 8.53%!

You do have to pay taxes on all I-bond interest, including the inflation portion, so they are not a full inflation hedge. Interest accrues in the value of the bond and becomes taxable income upon redemption. I am not sure if there are state income taxes on I-Bond interest.

Please note that there are severe restrictions on I-Bonds, such as limits to how much you can purchase ($5,000 in any calendar year) and early redemption penalties (you can't redeem in the first year after purchase and forfeit 3-months' interest if you redeem within the first five years.)

You can purchase Treasury I-Bonds via the TreasuryDirect web site or from a bank.

The good news is that you do not have to pay a "broker" even one dime in direct or indirect form to make this kind of investment.

See I Savings Bonds Rates & Terms.

I personally have never purchased a Treasury I-Bond, but I am thinking about it. It is a small amount of money, but a great way to have a little money "working" for you without any further effort on your part and is "out of sight, out of mind", so you won't be tempted to spend it. And the inflation hedge is attractive.

-- Jack Krupansky

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