Thursday, October 20, 2005

I-Bond, EE-Bond

The current interest rate of Federal Government's inflation-fighting
savings bond, popularly known as I-bond, is 4.8%. That consists of a fixed
rate of 1.2% and a semiannual inflation-adjusted rate of 3.58% (The slight
discrepancy in total is due to the way the composite is calculated). Both
components are adjusted every May 1 and Nov. 1.

The other savings bond that is adjusted semiannually is the EE series. It
currently pays 3.5%. It's a fixed-rate bond, so the rate you get when you
purchase stays with you until you sell. It has the same holding and penalty
provisions as the I-bond. It is expected that EE-Bond's new interest rate
will continue to remain right around 3.5% after Nov 1.

However, due to inflation that can be easily detected around us, it is
estimated that the interest rate on I-bond could come in above 6% when
it's adjusted Nov. 1. The fixed rate, in effect when the bond is purchased,
stays with an investor for as long as he owns the bond. The inflation-
adjusted component is based on inflation data for the previous 6 months
as measured by the U.S. Consumer Price Index.

CPI numbers for the previous six months gives an annualized inflation
rate of 5.7%. That ombined with the current I bond's 1.2% fixed rate may
give an effective rate of 6.9%. But with a rate that high there's a strong
likelihood that the fixed rate will get reduced. But even if it gets scalped all
the way down to 0.5%, the I-bond would still have a composite rate of
approximately 6.2%.

There is an advantage in buying I-bond right now. You will get 4.8%
(=1.2%+3.58%, as explained in first paragraph) for the next 6 months
until late April when only the adjustable rate will be increased to whatever
inflation component is issued on this coming Nov. 1. If that combined rate
is 6.9%, you'll be able to average 5.85% for the full year.


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