Friday, June 26, 2009

It's a terrible time to buy US Savings Bonds. Will there ever be a good time again?

I doubt it. I mean, in case you were thinking about buying some, be warned. Don't.

"Regular" Series EE bonds being issued today pay all of 0.7% interest.

Inflation-adjusted Series I bonds being issued today pay a nifty 0.0% through this coming October 31. This amount is comprised of an almost as nifty 0.1% real permanent interest rate to be paid over the life of the bond, plus an additional amount to account for inflation that is adjusted every six months. (In the case of deflation this later amount can reduce the total combined rate to, but not below, 0.0% -- thus the current rate).

The thing about Savings Bonds is that they usually are held as long-term investments -- people give them as gifts to newborns to provide a figurative start on college savings, grandma hides a shoebox full of them in a clost to feel secure. And so on.

They aren't marketable, and if redeemed within five years there's a penalty. But these rates are awful for long-term investments. They embody Warren Buffett's warning against being invested in long-term US bonds, writ small.

When the recession ends, and a normal economy resumes, it is hard to imagine that the 0.7% rate on today's Series EE bonds will come anywhwere close to even matching inflation, much less pay any real interest return. So they will be pure money losers, long-term. Possibly serious money losers: if inflation averages only 2.5% over the next 20 years, an EE bond bought today will lose 30% of its value by its maturity date.

(Even today, bank CDs guaranteed by the government with five year maturities, the shortest penalty-free holding period for a savings bond, pay a bit over 3% -- more than four times what EE bonds pay.)

Somewhat less bad are Series I bonds, if tradition or whatever demands that you make someone a gift of Savings Bonds. At least I bonds won't actually lose value, due to their inflation protection. Though with a 0.1% real interest rate, when they mature 20 year from now they will be worth only a real $1.02 for every $1.00 invested in them today, so your gift isn't going to make anyone rich.

The base interest rates paid on newly issued EE and I bonds is reset every six months and will change this coming November 1, but that won't really change anything of substance. Savings Bonds have simply become a bad deal compared to the alternatives.

There is speculation that the Treasury is moving towards eliminating Savings Bonds altogether, as it recently dropped the limit on annual purchases to $5,000 from $30,000. At the same time it has lowered the minimum purchase price for regular US bonds, notes and T-bills to only $100, and made it easy to purchase them online with no fees or commissions at Treasury Direct. (As recently as 1998 the minimum purchase of T-bills was $10,000).

Regular US bonds, notes and bills get better rates than Savings Bonds and are the most marketable of all securities at all times (with no penalty) so they dominate Savings Bonds two ways right there. Really, you should probably never buy a Savings Bond ever again.

About the only meaningful advantage Savings Bonds have left is that you can still buy them in paper form, stick them in an envelope and hand them to someone as a gift. But then that someone can lose or forget them. (As I can attest, regarding all the bonds I got handed for my kids.) While regular Treasury securities today are recorded in electronic format.

But you can easily make a gift of a regular T-bond, note or bill, write a note saying you did, stick that in an evelope, and everybody involved will be better off.

Savings Bonds had their run -- in an era when the Treasury issued regular bonds in denominations up to $500 million each (about $4 billion or more in today's money) to save itself the trouble and cost of processing interest coupons physically clipped and sent to it from half a million $1,000 bonds for every one $500 million bond issued.

But that era is over -- one more example of the Internet changing everything.