Wednesday, April 02, 2008

Looking at I Bonds for protection against inflation

For the last few years, with my savings in high-yield savings or money market accounts, I haven't worried too much about interest rates and inflation. "All I want is to keep my savings safe and beat inflation," I kept telling myself, "so I'm doing fine." But with my bank account's APY dropping (from 5.00% to 4.15% to 3.30% in the last six months) and inflation climbing, I am starting to feel rather nervous.

Part of why this money is important to me is because it will give me the freedom to make the best choices for a happy and fulfilling life in the short term (not just decades from now at retirement age.) When I leave my current job (probably in the next couple years), I want my options to be wide open: I want to be able to take some time to travel-- to be able to take whichever job I think I'll like best, regardless of salary-- to consider working part-time and/or trying to work as a writer. The cushion of savings I've built up (about $50,000 at this point) is vital to giving me those opportunities, but I'm starting to worry about inflation, which could shrink the amount of time I'd be able to live on my savings if the interest I earn doesn't keep up. This would probably only happen to a relatively small degree, so it's likely that I'm feeling more anxious than I ought to be, but of course there's always a chance that there'd be more dramatic inflation.

So I've been looking at I Savings Bonds. They're sold by the federal government, and this is how they work:

  • Interest rates:
    • When you buy an I Bond, one portion of the interest rate is fixed for as long as you hold that bond. Right now the fixed rate is 1.20% (anyone buying I Bonds between November 1, 2007 and April 30, 2008 gets that fixed rate), but they announce a new fixed rate every six months for new buyers.
    • The other portion of I Bond interest changes every six months for everyone, based on the Consumer Price Index. So it's basically designed to neutralize the effects of inflation for you.
    • When you put the two portions together, theoretically you get a guaranteed, fixed return over inflation. (The only problem would be if the published CPI-U doesn't reflect the actual inflation you experience.)
    • The current rate is 4.28%, but that will change in May.
    • More about I Bond rates from TreasuryDirect.gov
  • Term:
    • You have to hold I Bonds at least 12 months.
    • If you sell your I Bonds before you've had them for 5 years, you forfeit 3 months' worth of interest as a penalty.
    • You can hold the bonds for up to 30 years.
  • Taxes:
    • The interest you earn is exempt from state and local taxes.
    • You don't have to pay taxes on your interest until the year you redeem the bonds.
    • If you cash out the bonds to spend them on qualified education expenses, you don't have to pay taxes on the interest at all.
    • More on I Bonds and taxes from TreasuryDirect.gov
  • Miscellaneous:
    • If you buy your bonds before the last day of a month, you get the full month's worth of interest. (It also counts as a "month" for the 12-month holding requirement.)
    • You can only buy $10,000 in I Bonds a year ($5,000 max online and $5,000 max in person), although this was lowered only a few months ago and apparently some people are still having luck buying up to $30,000 online.

With those factors combined, I think buying some I Bonds is a good financial choice for me right now. (I'll probably wait another couple weeks and see if people are guessing the fixed rate will go up or down on May 1, before I decide whether to buy in late April or late May.) They'll give me the peace of mind of knowing that, barring some serious governmental collapse, the money I put into I Bonds today should be worth as much or more to me when I access it in the future.

The biggest drawback for me isn't financial, it's having to withdraw a big chunk of my money from my community development bank, knowing that less of my money will be invested in doing good for communities and the environment. Because of that, I wouldn't pick I Bonds if we were talking about a small, fixed difference in interest rates-- but major inflation could create a big difference, and so it's worth it to me to protect some of my money against that.

What do you think about my plan? Do you own I Bonds, or are you planning to buy some? What do you think about them? Do you try to protect against inflation in other ways? Do you have any predictions or expectations about inflation?

3 comments:

julie said...

hi there, just discovered your great blog. tom adams at http://www.savings-bond-advisor.com/ has a ton of helpful information about i bonds. his prediction is that the fixed rate will go down unless the tips rates miraculously shoot up again. i just bought $2000 worth of i bonds at the end of last month and am thinking about trying to free up a little more to sink into them before may. at this point it makes more sense than keeping that money in a MMA as long as you don't need to touch that money for at least a year. i don't foresee inflation going down anytime soon.

one thing to note - if you've never bought bonds online, sign up a few weeks before you're planning on buying them, because you have to wait for them to mail you a weirdly complicated "membership card" thing in order to sign in and purchase online.

Peter said...

Does anyone know where I can find solid impartial views on UK based bonding? I need bonds for various things so ideally I am looking for a site which reviews many companies and packages. I have found JW surety bonds and they seem to be reputable but I am just not wanting to go ahead until I can read more reviews or something, especially about their mortgage bonds as that's my priority.

Toddy said...

I think you are a little bit confused Peter, surety bonds are not a requirement in the UK. There are other types of insurance cover you can obtain but generally speaking "surety bonds" are not relevant and only applicable in North America.