Wednesday, February 15, 2012

I Bond and CD Update: February 2012

There have been some significant changes to I Bonds since my original I Bond post in May 2011 and my I Bond update in June 2011, and CD rates have continued to fall since my previous CD posts. Following is a summary of the I Bond changes, and my latest recommendations for how you might use I Bonds and CDs in your investment portfolio. If not mentioned here, the information in my previous I Bond and CD articles still applies, so refer to those for more details.

Changes to Series I Savings Bonds for 2012:

  • You can no longer purchase paper I Bonds, either from a bank or by using an online mail-in order form. The only way to purchase paper I Bonds is by using your tax refund, for which the limit is $5,000 per tax return.
  • The annual purchase limit for buying I Bonds in electronic form from TreasuryDirect has been increased from $5,000 to $10,000 per person or entity.
  • The current I Bond annual interest rate is 3.06% (1.53% semi-annual rate). This rate applies for the first six months for I Bonds purchased before May 1, 2012.
  • TreasuryDirect accounts no longer require an Access Card to access your account. Instead, a one-time passcode (OTP) is sent to your email account, and is used to register your computer. Once registered, you only need your account number and password to log in. Here is a link to a Demo of the new account login process:

Note that the annual purchase limit is effectively unchanged, unless you use your federal tax refund to purchase paper I Bonds, in which case it actually has increased by $5,000: $10,000 through TreasuryDirect + $5,000 with tax refund = $15,000 for one person. Of course you still can buy the annual limit through TreasuryDirect for each person (e.g., you, spouse, children, grandchildren, etc.) and for your living trust.

If you purchase I Bonds by April 30, 2012, you will receive 1.53% (3.06% annualized) for the first six months. The rate for the second 6-month period depends on the inflation rate for the six months ending March 31, 2012. So your worst-case 1-year return will be 1.53%; this assumes 0% inflation for the six months ending March 31, 2012. If you can beat a 1.53% annual return on a 100% safe, state-tax-free, federal-tax-deferred investment, please let me know!

So, how might I Bonds and CDs fit into your portfolio in the current low-interest-rate environment?

As discussed in my previous I Bond posts, I Bonds are available only in taxable accounts, not in tax-advantaged accounts such as IRAs and 401k or 403b plans. You probably want to put a higher priority on saving for retirement in your tax-advantaged accounts before considering buying I Bonds in a taxable account. An exception might be using I Bonds to build up your emergency savings, keeping in mind that you won’t be able to sell an I Bond until one year after purchase.

If you have maxed out your contributions to your tax-advantaged accounts, and have paid down all of your high-interest-rate debt, then I Bonds probably are your best bet for a low-risk investment for money that you won’t need for at least one year.

For money that you may need in less than 1 year, but not for at least 4 months, I still like Ally 5-year CDs the best. As of today, the APY is 1.74%. Since the early withdrawal penalty (EWP) is only 60 days of interest, if you do an early withdrawal after 4 months, your effective annualized rate is about 0.87%, which beats most high-yield online savings accounts (current yield on Ally online savings account is 0.84%). Hold the CD for 5 months and your effective annualized rate is about 1.04%, which beats the highest online savings rate of 1.0% that I currently see at Ally CDs can be held in either an IRA (Roth or Traditional) or a taxable account (individual, joint, trust, etc.).

If you think interest rates are going to stay low for a few years, then a PenFed 7-year CD with a current APY of 2.76% is worth consideration for your low-risk money. PenFed CDs can be held in an IRA or taxable account. The EWP is one year of interest, so the Ally 5-year CD is a better deal if you do an early withdrawal within about 2.5 years of purchase, after which point the PenFed 7-year CD will give you a higher return.

I Bonds give you inflation protection but CDs don’t, so deciding between I Bonds and a PenFed or Ally CD in a taxable account depends on your guess about the average inflation rate over the next few years. Also the annual purchase limit on I Bonds may be a limiting factor for you, so if you have a large taxable account, you may want to max out your annual purchase limit of I Bonds, then buy CDs with the rest of your low-risk money. Remember not to exceed the FDIC insurance limits on your holdings at any one bank.

All I’m discussing in this post are very low-risk investments, where you are guaranteed not to lose any of your principal (original investment). For long-term money with which you are willing and able to take some risk, I would look at Vanguard bond funds, stock funds, or balanced funds (stocks and bonds in a single fund). I have posted many articles on these funds, so search my blog to learn more about these higher-risk investments.

Let me close with a review of how I Bonds have worked out if purchased shortly after I wrote my first I Bond post on May 14, 2011.

If you did as I did and purchased I Bonds in May of 2011, you earned 2.3% for the 6 months ending October 31, 2011, and will earn 1.53% through April 30, 2012. Note that these rates are the semi-annual rates (one half of the annualized rates). If you sell your I Bonds on May 1, 2012, you will lose the most recent 3 months of interest (1.53% x 1/2 = 0.765%), so your total 1-year return will be 2.3% + 0.765% = 3.065%; not bad for a super-safe investment in this period of extremely low interest rates. Your return actually will be slightly higher if you bought your I Bonds in late May of 2011, since you will have received interest for the entire month of May.

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