Savings Bonds: Sometimes Conservatism Pays
The dowager of the investment world--the U.S. Savings Bond--has become more attractive to long-term savers since the Treasury Department announced that the bond’s variable rate soared 1.22 percentage points--the second-biggest jump in history.
With yields approaching 6% and rising, it may be time to take a new look at these conservative investments. Indeed, because Savings Bond yields are adjusted every six months, the bonds offer unique opportunities in times of rising rates, assuming investors don’t mind locking up their money for a few years.
That’s because investors who hold Savings Bonds for five years or more get the higher of either a guaranteed 4% return or a market-based rate. The market-based rate is 85% of the five-year Treasury note average, currently 5.92%.
Why not just buy a five-year Treasury note? Because in times of rising interest rates, there’s no upside on the notes. You get the contracted interest rate--no more, no less. Assuming you hold the bond to maturity, you also get your principal back. But if interest rates continue to rise, you may miss opportunities to earn more in the meantime.
Also, unless you buy directly from the Federal Reserve System, you pay brokerage commissions when trading Treasury bills, notes and bonds.
Savings Bonds are sold without fees through banks, thrifts and some credit unions. Some large employers also sell the bonds through employee thrift plans. And for bonds purchased after 1982, the interest rate is adjusted every six months.
The result: Even though you’re investing for a relatively long period, the interest rate is calculated to give you the same return as if you had purchased a six-month certificate of deposit and rolled the money into a new CD each six months for five years. In other words, if you hold the bond for five years or longer, you don’t miss out on interest rate upswings.
After five years, you can cash in the bond or hang on to it for as long as 30 years. After 30 years, it stops earning interest.
The catch?
For one thing, the market-based rate calculation that can help you in times of rising rates can hurt you when rates are falling.
People who bought Savings Bonds in November, 1982, for example, were told that the market-based rate was 11.09%, which was true for the next six months. After that, however, interest rates began to fall fast, and the new market-based rates began to eat away at the total interest the bonds would pay. The end result: The actual interest rate on these 1982 bonds, if cashed in today, would amount to just 7.5% annually.
Also, Savings Bonds are rotten investments for short-term savers or for anyone who needs regular income from investments. Unless you’re facing a dire emergency, you’re barred from cashing them in for at least six months. If you cash in a bond purchased after 1993 within five years, you get the pallid 4% guaranteed rate instead of the market-based rate. The market-based rate is only for those who hold their bonds five years or longer.
A Savings Bond continues to pay interest for 30 years from the date of purchase, regardless of the maturity date, says Peter Hollenbach of the Treasury Department’s bureau of public debt. And because they’re obligations of the U.S. Treasury, the bonds are secure and the interest earned on them is free from state and local taxes. You do have to pay federal tax on the earnings, but not until the bonds are cashed in.
*
Still, these bonds are more complicated than they appear, so investors need to be cautious, says Daniel J. Pederson, president of Savings Bond Informer, a Detroit-based consulting firm, and author of a new book, “U.S. Savings Bonds.”
While it’s easy to buy and redeem the bonds, the way interest is calculated can be deceiving. For instance, on bonds purchased after 1993, interest accrues each month for the first five years, or 60 months. After that, it’s paid just twice annually. If you cash in a bond the day before the interest is paid, you miss out on nearly six months of earnings. In dollars and cents, that means somebody holding a $1,000 bond at 6% would lose $30.
There is nothing on the face of the bonds to indicate the interest rate you’re entitled to or when the bonds are guaranteed to mature. And because guaranteed interest rates have changed numerous times and market rates change often, neither question is easy to answer. You are charged with knowing the rules--or learning them by asking a banker or the Treasury Department for a “Table of Redemption Values,” otherwise known as a PD-3600.
To find out what a particular Savings Bond is worth, go to any bank that sells the bonds and ask to see the redemption tables. By looking at these, you should be able to determine the current value of each bond you hold.
If you can’t find a helpful local banker, you can get a table of redemption values directly from the Treasury. Just send a postcard with your name and address, requesting a PD-3600. This is a table that shows the value of $50 and $25 notes and bonds. (If you own $100 bonds, double the value of the appropriate $50 bond.)
Send requests to Savings Bond Marketing Office, 800 K St. NW, Suite 800, Washington, D.C. 20226.
*
Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
