Betting
on Bonds Savings bonds still good deal despite longer holding
period
Source:
Advocate - Baton Rouge
Publication date:
2003-01-27
In
October, I urged fixed-income investors to consider buying U.S. Savings Bonds
before new rates took effect Nov. 1. But conditions have changed since then. Are
savings bonds still a good deal?
Back
then, the case for savings bonds went like this:Rates on the Patriot bond, also
called the EE bond, were quite generous, 3.96 percent for the first six months.
Government-backed savings bonds are extraordinarily safe. Unlike most other bond
types, savings bonds guarantee that you get all your principal back, plus
interest. Other bonds can fall in value if prevailing interest rates rise and
you have to sell.
In
fact, Patriot Bonds automatically pay more when interest rates go up, since
their yield is recalculated every six months to equal 90 percent of the yield
paid by five-year Treasuries.
And
finally, you don't have to tie your money up for the long run, even though a
savings bond continues to pay interest for 30 years. You can redeem a savings
bond as soon as six months after buying it, though you lose the final three
months' interest earnings if you do so in the first five years. But that's not
so bad.
Well,
the rule is changing. Earlier this month, the Treasury Department announced that
the minimum holding period will be extended to one year, starting with bonds
bought Feb. 1 and later. The change also applies to inflation-indexed "I
bonds."Why? Because the government doesn't want you to do one of the things I'd
suggested - to redeem early if other investments start to look more appealing.
Had
you bought a Patriot bond before Nov. 1, you would earn about 2 percent over the
first six months. Give up three months' earnings by redeeming then, and you'd
still have made 1 percent - probably more than you could have made in other safe
investments.
For
example, six-month Treasury bills pay about 0.6 percent over six months, while a
six-month certificate of deposit at a typical bank may pay 0.75 percent over
that period. (Higher rates listed for these investments are "annualized" rates -
what they'd come to over a full year.)In other words, a Patriot bond could be
used as an ultrasafe place to park money for the short term despite the early-
redemption penalty.
Well,
the government doesn't want the hassle and expense involved when investors use
savings bonds this way. When it sells a bond, the federal government is
borrowing from the bond buyer, and it wants to keep the money longer than six
months.
The
unusually large "spread," or difference, between the generous rates paid by
savings bonds and the lower ones paid by other short- term investments attracts
the wrong kind of investor, as the government sees it.
"The
new holding period will prevent purchasers from taking advantage of the current
spread between savings bond returns and historically low short-term interest
rates by cashing in bonds after six months," said the Treasury Department
statement. "Savings bonds are designed to be a long-term savings vehicle."Darn!
With
this change, are savings bonds still worth considering?
Sure.
They're still a safe, convenient way to protect money and benefit from
interest-rate increases.
But
they're not quite as generous. Patriots sold until May 1 will pay at an annual
rate of 3.25 percent for the first six months. That's 0.71 of a percentage point
less than the pre-Nov. 1 batch, but it's still pretty good. One-year CDs are
averaging about 2 percent.
What
about I bonds?
Those
bought before May 1 will earn 4.08 percent for the first six months, before
beginning their cycle of semiannual adjustments. New rates are set by adding the
inflation rate to a "fixed rate" of 1.6 percent, which is good for the life of
the bond.
Though
the I bond is more generous today, experts think that, as adjustments are made
down the line, the low 1.6 percent fixed rate will make them less generous than
Patriots in the long run.
Jeff
Brown is a columnist for The Philadelphia Inquirer, Box 8263, Philadelphia, PA
19101. His e-mail address is jeff.brown@phillynews.com.
Publication
date: 2003-01-27