No. of Recommendations: 2

I tried looking over the treasury direct site but was a little confused about how an I bond's rate will change over time.

I bonds have a fixed rate and a variable inflation-adjusted rate that is added on.

If I bought a bond today, at a fixed rate of 1.10, then bought another 6 months from now, at 1.50% (example): Would the second bond I purchase always have a higher yield?

I'm presuming the first bond would always have a lower fixed rate portion to add to the variable part? Or will the fixed rate change as well?

I was going to buy 5K of I bonds but am thinking it may be worth either waiting till rates improve, or purchase at a slower pace to "average in"...

No. of Recommendations: 1

*If I bought a bond today, at a fixed rate of 1.10, then bought another 6 months from now, at 1.50% (example): Would the second bond I purchase always have a higher yield?*

Good questions.

The fixed rate remains fixed for the life of that bond, while the variable inflation-adjusted rate changes every 6 months. But fixed rates on NEW bonds may change every 6 months.

For example, I have some I-bonds from a few years ago with a 3.6% fixed rate. But I also bought some bonds the other day with the 1.1% fixed rates. For the life of these bonds, the ones with the higher fixed rate will always pay 3.6 - 1.1 = 2.5% MORE than the recent ones. That's because the inflation rate for both bonds will be the same and adjust together every 6 months.

So the answer to your question above is yes. If the fixed rate increases to 1.5% in the fall, then those bonds will always yield 0.4% higher than the ones you buy today.

No. of Recommendations: 1

Greetings goodald,

*If I bought a bond today, at a fixed rate of 1.10, then bought another 6 months from now, at 1.50% (example): Would the second bond I purchase always have a higher yield?*

http://www.savingsbond.gov/sav/sbifaq.htm mentions a case where I think you'd have a tie between the bonds in terms of yield:

"In the rare event that the CPI-U is negative during a period of deflation and the decline in the CPI-U is greater than the fixed rate, the redemption value of your I Bonds will remain the same until the earnings rate becomes greater than zero."

Aside from that one case, the other bond will yield more if you look at the I-bond return formula of Fixed rate+2*Inflation rate+Fixed Rate*Inflation Rate where * is my symbol for multiplication.

*I was going to buy 5K of I bonds but am thinking it may be worth either waiting till rates improve, or purchase at a slower pace to "average in"... *

I suppose this would lead to a few questions from my perspective, not the least of which is how long are you prepared to wait and where would the money be invested in the interim?

Regards,

JB

No. of Recommendations: 1

Greetings Foolferlove,

*For example, I have some I-bonds from a few years ago with a 3.6% fixed rate. But I also bought some bonds the other day with the 1.1% fixed rates. For the life of these bonds, the ones with the higher fixed rate will always pay 3.6 - 1.1 = 2.5% MORE than the recent ones. That's because the inflation rate for both bonds will be the same and adjust together every 6 months.*

What happens if the inflation rate is -1.8% or lower? I'll admit the likelihood of this isn't high but run the numbers in this case.

In this case both bonds would have a negative yield according to the formula but http://www.savingsbond.gov/sav/sbifaq.htm states : "In the rare event that the CPI-U is negative during a period of deflation and the decline in the CPI-U is greater than the fixed rate, the redemption value of your I Bonds will remain the same until the earnings rate becomes greater than zero."

Regards,

JB

No. of Recommendations: 0

Thank you Foolferlove and JB

You both answered my questions and raised an interesting point.

>>>>>

What happens if the inflation rate is -1.8% or lower? I'll admit the likelihood of this isn't high but run the numbers in this case.

"the redemption value of your I Bonds will remain the same until the earnings rate becomes greater than zero."

<<<<<

I actually didn't realize that I bonds could have zero growth, I thought the fixed portion would always pay. I'll keep thinking about my options for now. I'm not really in a hurry to stick my cash anywhere.

-My E-fund's pretty built up

-I've also saved an additional 5K that i'll eventually be using to help pay off my student loans.

Still Fulltime worker+student, loans won't come due for 2-3 years. I'm looking for a safe account with yields near to my student loan interest rate. Currently my E fund and tuition fund are both in INGdirect, which is paying 2% (just lowered again, sigh). I'm trying to keep as much cash on hand as possible in case "something" happens where I work. I'm almost certain that i'm safe here... but "almost certain" doesn't mean much nowadays :)

Thanks again for your feedback!

No. of Recommendations: 0

*What happens if the inflation rate is -1.8% or lower? I'll admit the likelihood of this isn't high but run the numbers in this case.*

Yes, absolutely right jb. If the CPI-U is negative, or technically, more negative than the fixed rate of one of the bonds, then the difference in yields would not remain constant and could even decline to zero if CPI-U numbers were negetive enough compared to the various bonds under consideration.

Thanks for bringing up this subtle point, but very important point considering the deflationary talk that surrounds us today.

No. of Recommendations: 2

*If I bought a bond today, at a fixed rate of 1.10, then bought another 6 months from now, at 1.50% (example): Would the second bond I purchase always have a higher yield?*

As others have pointed out, the higher fixed-rate bond would always have a higher yield. But note that you can always cash in the lower-yielding bonds, and buy some new ones with the higher yield. There are only three things to worry about:

- The three-month interest penalty, if this is done before the initial five-year holding period is over. If you intend to hold for a long time anyways, this penalty may be small compared to the extra yields you would receive.

- Selling the bonds exposes the earned interest to taxes. How much this affect you depends on your own personal tax situation, of course.

- The purchase limit of $30,000 per year. Say, after a few years of savings bonds, you collect $50,000 worth. At that time, the fixed rate moves up. You would not be able to cash in all $50,000 and buy a new set of bonds $50,000, due to the purchase limits. Of course, you could exchange $30,000 worth, and leave the rest for another year.

The ability to cash in savings bonds at any time helps make it possible for you to take advantage of better deals right away, should they come along.

No. of Recommendations: 1

J.B. is right that with sufficient deflation to wipe out the fixed rate or two I-bonds with different fixed rates, they would both yield zero. Otherwise the one with the higher fixed rate will always have a higher yield by the amount the fixed rate is higher.

However, if you are new to this continuing discussion, historically EE bonds have yielded more than 2% over inflation (going back a long way through all kinds of ups and downs). Research modeling suggest I-bonds would have to have a fixed rate of more than 2.25% to outperform EE bonds long term. At the moment I-bonds look good, but if you're looking to hold to maturity or close, them you're probably going to do better with EE. Then there's also no point in waiting until a fixed rate goes up, because EE bond rates will fluctuate with the market.

No. of Recommendations: 1

Greetings Foolferlove,

* If the CPI-U is negative, or technically, more negative than the fixed rate of one of the bonds, then the difference in yields would not remain constant and could even decline to zero if CPI-U numbers were negetive enough compared to the various bonds under consideration.*

Not quite right actually. The formula to determine the composite earnings rate on an I-bond is as follows and isn't simply a sum of the 2 rates:

"Composite rate = [Fixed rate + 2 x Inflation rate + (Inflation rate X Fixed rate)] X 100%"

From http://www.savingsbond.gov/sav/sbirate2.htm

So, if the fixed rate is 1.1% and I wanted to know what the inflation rate had to be in order for the composite rate to be zero, I could simply solve the equation as follows:

0 = .011+2x+.011x

-2.011x=.011

x = 0.0054699154649428145201392342118349 or about .55% or just under half the fixed rate.

Regards,

JB

No. of Recommendations: 0

"The ability to cash in savings bonds at any time helps make it possible for you to take advantage of better deals right away, should they come along."

This is the real crux that has fueled my interest in I Bonds. Why park cash in my ING account or other various savings accounts, or cd's, or EE Bonds when I can earn superior interest to all of these and still be able to sell after 12 months with only a 3 month interest penalty? I'm thinking that even with the penalty, I'll still come out ahead of even my ING account. And the only real rason to sell would be to put the money into something better such as a higher interest bearing I Bond (and that is certainly going to come around before the five year drop dead date). A better strategy would be to average in and to hold each I Bond for the full five years before cashing them in since, by comparison, I Bonds will probably always perform better than savings accounts and cd's at the same points in time. And the best part is the liquidity. I can go to my local bank anytime and exchange them for cash. Later...

No. of Recommendations: 0

JB,

*or about .55% or just under half the fixed rate.*

Actually, that's the inflation rate for the 6-month period. When you annualize it (which is how we all usually discuss the CPI-U), it comes out to be equal to the fixed rate, more or less.

Ken

No. of Recommendations: 1

*Research modeling suggest I-bonds would have to have a fixed rate of more than 2.25% to outperform EE bonds long term.*

This is really the crux. And the government does not publish a formula for guessing I-Bonds fixed rates.

EE bonds are guaranteed to reach face value in 17 years, an equivalent of 5% at my projected retirement tax rate.

That said, I plan to buy I-Bonds this week for the short term.

I just wish that the Fed would have realized that pegging I-Bonds to arbitrary fixed rates causes uncertainty.