U.S. savings bonds are essentially loans to the Government from whoever is willing to make them. Due to the stability of the U.S. Government, these bonds are considered safe i.e. low risk investments. The receipt for the loan is called a Bond and carries an interest rate paid to the bond holder along with the final face value of the Bond. Depending on the type of bond interest payments vary, and maximum holding periods are between 20-30 years.
Options: If one includes Treasury Inflation Protected Securities, there are four types of U.S. savings bonds according to the U.S. ‘Treasury Direct’ website http://www.savingsbonds.gov. These bonds can be purchased directly from the U.S. Treasury Department of Public Debt website or through financial institutions such as commercial banks. The U.S Treasury’s Bonds are illustrated as follows:
*EE/E: These bonds are fixed rate bonds are fixed rate bonds with interest rates competitive with some money market accounts and less than some Certificates of Deposit. The interest and face value of these bonds are payable upon maturity and/or redemption and the income is state and locally tax free.
*I: Also known as I-Bonds or Inflation Bonds. These bonds offer fixed rates of return competitive with some money market accounts and interest is payable upon redemption.
*HH/H: Pay bi-annual taxable interest through direct deposit at a lower interest rate but are not currently being issued by the U.S. Treasury.
*TIPS: Offer higher yields that vary in accordance with the consumer price index inflation gage. Interest and face value are paid upon redemption and interest is applied bi-annually.
Benefits: Holding savings Bonds almost guarantees the bond holder savings that yield between 1-7% if EE, 3-4% for I 1-4% and 5-7% for TIPS. These benefits can be useful retirement savings tools because all but the HH/H bonds can provide state and local tax free or tax deferred interest income at a higher rate than savings, checking and some money market accounts. Bonds can also be held, bought and sold electronically essentially eliminating the need to go to a bank for bond related activities.
Risks: An opportunity cost presents itself in the holding of bonds. For example, if a U.S. Savings Bond is paying 4.75% interest and a commercial certificate of Deposit is paying 5.5% one is losing 75 basis points in opportunity cost. Additionally, U.S. savings bonds are locked money until the non-redemption period expires, and even though they can be redeemed prior to expiration, there is an interest forfeit penalty associated with early redemption.
Costs: Bond prices vary based on the type of bond issued. I-Bonds and EE/E bonds come in denominations as small as $50 and as large as $10,000 whereas HH/H bonds’ smallest face value is $500.00.
Ideas to Consider before Purchasing Bonds:
In terms of getting the most return on money loaned, TIPS offer the best interest rates of the bonds discussed above. However, depending on what one’s needs are the HH/H Bonds might be a useful source of liquidity if held in a large volume. Since EE/E bonds and TIPS have tax deferred interest income both these financial instruments are possible considerations for a retirement portfolio.
The time value of money is also an important consideration because the longer one holds a Bond the greater the potential decrease or increase in savings is in relation to alternative financial investments. For example, in reverse of the opportunity cost risk mentioned above, there may also be adversity protection from harsh market conditions, recessions or any other event that might reduce the value of non-Government backed investments. As time progresses the combination of market forces, economic conditions and investment decisions amount to either an opportunity cost or gain depending on the circumstances.
Bonds are generally secure and stable investments that can anchor an otherwise volatile investment portfolio. However, if one invests entirely in HH/H or I bonds, one may forfeit higher returns available through other investment vehicles. Since some bond rates are variable the rate can become more favorable after one has purchased them. In this respect it can be wise to consider past, present and possible future prices of bonds when deciding whether or not to buy them.