Trying to make it easier for people to save more is a noble goal. But inviting people to pursue terrible investments isn't the right way to do that job.
Making saving easier
Over the holiday weekend, President Obama announced several initiatives to give workers more options to save. Some of the ideas were useful. For instance, one proposal would make it easier for small and medium-sized businesses to enroll their workers automatically into employer-sponsored retirement plans such as 401(k)s. Another would allow workers and employers to convert unused vacation pay and sick leave into 401(k) contributions.
However, one of the proposed ideas wasn't nearly as constructive. The administration would make it easier for people to invest their tax refunds in U.S. savings bonds. Although that sounds like a reasonable goal, savings bonds are just about the last place anyone should put their money right now.
The problem with savings bonds
In the past, savings bonds offered several attractive options for savers. Traditional series EE bonds paid market-based rates that were as high as 5.7% back in 2000. Although those rates were pegged to Treasury securities, they still gave savers a competitive return, even when interest rates came down.
Series I savings bonds, which are adjusted for inflation, gave savers an even better deal. From the time they were introduced in 1998 through around 2001, I bonds gave investors a return of almost three percentage points or more above the inflation rate. That has translated over the years to some healthy returns for savers.
Now, however, rates on savings bonds are absolutely horrific. New series EE savings bonds, which offer a fixed interest rate throughout their lifetime, pay just 0.7%, even though they're designed for investors to hold for up to 30 years. Meanwhile, series I bonds pay just 0.1% above inflation. Right now, based on the recent deflationary trends we've seen lately, series I bonds aren't paying anything at all. Given those facts, it's ludicrous to suggest that anyone buy savings bonds right now.
The better way to invest
The administration's proposal would be more effective if it restored some of the positive benefits of savings bonds from years past. If the government returned interest rates to the more attractive levels of the past, it would make savings bonds a reasonable savings alternative.
As it is, though, anyone with a small amount to invest would be much better served by starting a mutual fund account. For instance, mutual fund providers like T. Rowe Price waive their usual minimums if investors commit to investing just $50 per month. Here's a sample of some investments you could make there:
|
Fund |
Objective |
10-Year Average Annual Return |
Holdings Include ... |
|---|---|---|---|
|
T. Rowe Price Equity Income (PRFDX) |
Large-cap value |
3.1% |
JPMorgan Chase |
|
T. Rowe Price Mid-Cap Value (TRMCX) |
Mid-cap value |
9.5% |
Discover Financial Services |
|
T. Rowe Price High Yield (PRHYX) |
High-yield bond |
5.7% |
Bonds issued by Ford Motor |
Source: Morningstar.
As you can see, even during a period when stocks have done pretty badly, each of these funds has done a lot better than the returns that savings bonds offer right now. The Mid-Cap Value Fund has more than doubled investors' money over the past decade. In contrast, even after 30 years of 0.7% returns, you wouldn't be anywhere close to doubling your money; you'd only have about $1.23 for every dollar you had initially invested.
Go elsewhere
Saving more is a good idea. But by itself, saving won't improve your financial situation much. To do the most good, you have to invest that money intelligently -- and right now, savings bonds simply aren't an intelligent option for investors. Mutual funds with low minimums and reasonable returns are a much better option, not just for better returns now, but also because of their long-term potential to let your money grow substantially over time.
