I-Bonds lose their attraction

Note: the current I-Bond rate was incorrectly noted in the original entry and has been corrected.

I-Bonds are inflation-adjusted savings bonds issued by the government. Holders earn a combined interest rate with 2 components; a fixed rate and an inflation rate. The base rate is fixed for the life of the bond. The inflation rate, which is based on the current CPI-U, is good for 6 months. The Treasury issues a new fixed rate and a new inflation rate every six months, on May 1st and November 1st, which reflect current market rates for both components. Holders of existing bonds will keep their original fixed rate but have the inflation component adjusted to reflect the current CPI-U.

As an example, current I-Bonds issued between November 1, 2008 and April 30, 2009 earn a combined rate of 5.64 percent. That is an attractive rate in today’s environment, and is due to the high inflation we experienced last fall as oil and food prices soared.

But inflation has decreased substantially since then – I’m sure you’ve noticed that gas is now around $1.80 per gallon vs. the peak of over $4.00 per gallon last summer. Unless we see a quick spike in inflation, the CPI-U will be negative at the next adjustment period (since the inflation rate always reflects the change in prices over a time period). The inflation-adjusted interest component of I-Bonds is never negative but would go to zero, leaving you with a very low total interest rate until the next adjustment on November 1st.

Buying an I-Bond now means you’ll get the attractive 5.64 percent rate for another six weeks or so, after which your rate will probably adjust to less than one percent. The fact that I-Bonds cannot lose money is an attractive option; however CDs will give you the same security without the uncertainty of changing interest rates.