Those Sexy Savings Bonds

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By Robert Brokamp (TMF Bro)
June 12, 2002

With rates on CDs and money markets down around our ankles, and returns in the stock market down through the floor, U.S. savings bonds are becoming the vehicle of choice for people looking for safety -- and inflation-adjusted returns!

Let's take a look at the options offered by good old Uncle Sam:

I Bonds: The "I" stands for "inflation," because the return on an I Bond is a combination of a fixed rate (established at the time of purchase) and a floating rate that is adjusted every six months based on the Consumer Price Index for all Urban users (CPI-U).

Series EE Bonds: The interest rate on EE savings bonds is based on the average yields for the preceding six months on five-year Treasury securities. The rate is adjusted every six months. (Thus, the rate is based on the marketplace, not on inflation. However, over the long run, the rates on Treasuries and the rate of inflation will generally move in the same direction.) EE bonds are purchased at half their face value (e.g., you pay $50 for a $100 bond) but are guaranteed to reach face value in 17 years -- a 4.24% annual return.

Series HH Bonds: This type of bond is the plain, homely sibling in the savings-bond family. Series HH bonds make semiannual interest payments based on a rate that doesn't change. The only way to acquire HH bonds is as an exchange for EE bonds or for HH bonds that have matured.

Treasury Inflation-Protected Securities: OK, we're cheating here. TIPS, as they're commonly known, aren't savings bonds but, rather, Treasuries. (The big difference: Treasuries are bought and sold on the open market, savings bonds are not.) But people are buying TIPS for the same reasons they're buying I Bonds: inflation protection from an investment issued by the U.S. government. The interest rate on TIPS stays the same, but the principal is adjusted to keep up with inflation. But it gets better: The interest is based on the pumped-up principal, so not only has the value of your investment increased, but you'll also receive more interest.

Though there are many differences among the aforementioned investments, they have some favorable characteristics in common:

  • They're issued by the U.S. government, which makes them the safest investments in the world.
  • They're exempt from state and local taxes. (EE and I Bonds have the additional tax advantages of tax-deferral, and can be tax-free if used for qualified higher-education expenses.)
  • They can be purchased commission-free at treasurydirect.gov.

Though savings bonds are very safe, they're not very liquid. If you are looking for an easily accessible, safe investment, visit our Short-Term Savings Center, which features special Fool-only rates on CDs and money markets.

There's a lot more to learn about savings bonds before you invest, so make sure you do your homework. Start by visiting the horse's mouth: www.savingsbonds.gov.

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