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URL:  http://boards.fool.com/let-me-phrase-some-questions-on-i-bonds-to-see-if-15566094.aspx

Subject:  Re: I Bonds Variability Date:  8/14/2001  11:34 PM
Author:  foobar73 Number:  1944 of 35367

Let me phrase some questions on I bonds to see if I understand how they really work. Right now the fixed rate is 3% and variable I rate is 2.9%. If I buy an I bond now what happens to this 5.9% rate when the treasury changes either fixed or variable or both? For example, if they change variable rate to say 2% does this mean that my 5.9% bond now becomes 5%? If they change the fixed rate to 1% does my bond remain at 5.9%? If only changes in variable rates affect older I bonds, doesn't this make them like a tax deferred money market account. except there is a fixed floor (3% now), and the rate can only change every 6 months?

If I understand them right, they seem like a pretty good deal, but don't expect your present 5.9% I bond to stay at that interest because it could drop all the way to 3%. On the other I bond rates could rise to very high levels if interest rates take off. Given all this, it seems I bonds could make a very easily managed bond ladder, you just buy them and forget them (for 30 years). What do you think?


The fixed 3% rate is, well, fixed. This will never change for the life of the bond. The variable rate is essentially the rate of general inflation, and will vary. If inflation goes to 2%, as in your example, your return changes to 5%. You are essentially correct in your "money market" analogy, except that the fixed floor is 0%: in case of deflation (negative inflation), the nominal return of I-bonds can drop below 3%.

You're also right about the laddering. Since I-bonds have inflation protection built in, you don't need to construct a ladder, but can simply buy and hold them.
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