Savings Bonds Offer Low Risk, Low Return

It’s little wonder that sales of U.S. Savings Bonds have declined in recent years. They pay a fraction of what can be made in today’s stock market, and figuring out how much interest they earn and what they’re actually worth can be an exercise in frustration.

But for those who want an investment with virtually no risk, or who are looking to fill out the conservative end of a diversified portfolio, savings bonds still appear to be relatively attractive. The interest on bonds is exempt from state and local taxes, and federal taxes don’t apply until the bonds are cashed.

The government is hoping its new series of inflation-linked bonds will make this form of savings even more popular. The I series, introduced in September, pays a fixed interest rate--3.3% recently. On top of that, it pays a rate, adjusted every six months, based on the consumer price index.

“So now, if you bought an I bond, you would have an annual return of 5.05%,” said Dino DeConcini, executive director of the U.S. Treasury’s Savings Bond Marketing Office. That’s as much as a 10-year Treasury bond pays now and would have beaten the 30-year bond yield in recent months. “People seem to be realizing this. The first month of sales was $18 million, and in October, it was $27 million.”

Additionally, the EE series bonds issued on or after May 1, 1997, are more attractive than older bonds. They earn 90%, versus the 85% on previous bonds, of what five-year Treasury notes are paying, meaning they’re earning more than 4.6%.

A new “EasySaver” plan is also aimed at getting more people to invest in bonds. Introduced in November, it allows people to have the government debit a bank account and purchase bonds automatically.

While this is a fairly common practice for those working at large companies, it was not available to people at small businesses, the self-employed or those who are retired. DeConcini said more than 2,400 people have signed up for the program.

Savings bonds were created in the 1940s to finance the war effort and became especially popular in the 1980s when they came with a 10-year guarantee of 7.5% interest. But that was reduced to 4% in 1993, and in 1995, it was replaced by a variable rate. Since peaking at $17.6 billion in fiscal 1993, sales have declined every year.

“From a patriotic standpoint, I guess [savings bonds] make sense, but I can’t see them making sense in a long-term portfolio,” said Craig Fischer, vice president and director of research of Atlantic Securities Inc. in Towson, Md. “Their rate of return is less than what can be achieved in a taxable area in the same time period.”

Bonds are also difficult to analyze. As with most investments, their rates can fluctuate.

“Americans forfeit $150 million each year by cashing bonds at the wrong time,” said Daniel J. Pederson, former director of the savings bond division of the Chicago-Detroit branch of the Federal Reserve Bank and author of “Savings Bonds: When to Hold, When to Fold and Everything In-Between.”

“You lose between $200 and $400 per $10,000 in bonds by cashing them at the wrong time,” Pederson said. “So if you have a stack of 50 bonds and you want to cash 10 or 20, you should cash the worst performers. People often pick them at random without knowing about the interest rate, so they cash the best-performing and keep the worst-performing when they really want to do the opposite of that.”

So, what are your bonds earning? Somewhere between 4% and 6.1%, depending on the series and the date it was issued and the rules in place at the time of purchase. One of the simplest ways to find out exactly what your bond is earning and what it’s worth is to visit https://www.savingsbonds.gov on the Internet.

By plugging in certain information, one can see that, for example, a Series E bond issued in December 1973 with a face value of $25 is now worth $105.40 and is earning 4% interest. Meanwhile, the same bond issued one month earlier is currently earning 6% interest.

Americans also seem to be confused, perhaps rightly so, about the length of time their bonds earn interest. All bonds issued before November 1965 were 40-year bonds, so anyone today holding a bond issued before 1959 is no longer earning interest. In December 1965, the government switched to 30-year bonds.

Pederson said there are about $5.3 billion in bonds that have stopped earning interest, and holding on to them means “you’re letting the government use that money interest-free. The government saves $275 million a year by using Americans’ money for free,” he said.

Despite the modest returns and the complexity surrounding them, U.S. Savings Bonds can still make sense.

“There’s virtually zero risk with savings bonds. Stocks have rebounded, but they could have been down 10%,” Pederson said. “Bonds don’t have double-digit gains, but they’ll never be negative. In everybody’s portfolio, they probably have a mixture of high- and low-risk investments, and savings bonds can fill the low-risk end.”