The Treasury Department this week set at zero the fixed portion of the yield on Inflation bonds, guaranteeing that new buyers will never earn more than the rate of inflation for the 30-year life of their investment.
This is what it has come to. The economy is so rotten; secure income is so hard to find that savers are lending money to the government for an inflation-adjusted return of…nothing. They just want to know they’ll get their money back without losing ground to a higher cost of living. Is that anyway to get ahead?
Strangely, it might be. I-bonds are a close cousin to Treasury Inflation-Protected Securities (TIPS), both of which have been around since 1998. Both pay a yield that rises and falls in line with inflation. With I-bonds, which are popular with individual investors, the rate you earn is a combination of a fixed rate that is somewhat mysteriously set by the Treasury (now at zero) and a fluctuating rate determined by change in the Consumer price Index. The new I-bond rate set this week is 3.06%, totally attributable the most recent CPI readings.
“The financial system is so screwed up at this moment that I-bond rates, even paying just the inflation rate, are actually competitive with most things out there,” says Tom Adams of Savings Bond Advisor. For example, bank CDs pay just 1% to 2%. With them you lose ground to inflation.
The beauty of I-bonds is the government guarantees that you will never lose ground to inflation and never be saddled with a loss, as can happen with TIPS (and most bonds) in periods of deflation. The total rate of return will never be less than zero.
The fixed-rate portion of I-bonds has hit zero before—once in 2008 and again one year ago. There was even a six-month period in 2009 when a period of deflation wiped out the yield altogether and I-bonds produced zero return. That experience along with today’s extremely low yields may help explain why I-bonds are losing their luster. New sales have plunged by about half since 2008, Treasury reports.
But savers may be missing the forest for the trees. Today’s rate of 3.06% is a full percentage point higher than the yield on a 5-year bank CD. (Five years is the shortest holding period for I-bonds without incurring penalties.) The federal income tax on I-bonds can be deferred up to 30 years; I-bonds are exempt from state and local income tax. Maybe locking in an inflation-rate return, for now anyway, isn’t so crazy after all.