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I Bond Yield Update - November 2009 through April 2010

I Bonds are back into positive territory with the Consumer Price Index getting back to inflationary numbers from a slight decline in prices in the previous measurement period.  As a result, I Bonds now yield 3.36% through April 30, 2010 that is comprised of a fixed rate of 0.30% and a 3.06% rate for inflation.  This represents an increase in both the inflation and fixed components that make up the I Bond Yield.  (For more information on how the yield is calculated, click here.)

Back in May, I suggested that you wait to purchase any additional I Bonds until the new yields were announced because for the period May through October of this year, you would have received exactly zero yield as a result of a low fixed rate (0.10% from last period) and a brief period of deflation.  At this point, Treasury has increased the fixed rate modestly to 0.30% and inflation, though tame, is enough to put yields well above money market accounts and 'high yield' savings accounts.  As a result, if you are filling out an emergency fund or looking for a nice, safe place for cash reserves, I Bonds are back to being your number one option.

Quick Stats on I Bond Fixed Rate Component

• Average Fixed Rate:  1.74%
• Median Fixed Rate:  1.35%
• Standard Deviation:  0.01155
• Lowest Rate:  0.00% (May 1, 2008 to October 30, 2008)
• Highest Rate:  3.60% (May 1, 2000 to October 30, 2000)

To learn more about I Bonds or to start an account with Treasury Direct, click here.

I Bond Yield Update

For a number of years, I have consistently recommended I Bonds for emergency funds beyond the first couple of months' worth of expenses.  The reasoning is simple.  I Bonds are pegged to semi-annual inflation readings and typically offer a fixed rate above inflation.  Unfortunately, the yield on the current lot of new I Bonds has fallen to 0.00%.  That's right, zip, zero, nada, zilch.

Though the current yield is zero, the bonds do pay a fixed rate of interest above inflation.  Once inflation returns the yield will improve.  To illustrate this, here is the current calculation:

     -5.56% inflation rate  +  0.10% fixed interest rate  =  -5.46% tentative yield

Since the yield is below zero, the current yield will be set at zero because I Bonds cannot yield negative returns.  The principal is guaranteed directly by the U.S. Government and the bonds are structured to keep pace with inflation while remaining flat during deflation (what we have right now).

When inflation returns, the fixed rate for I Bonds purchased today will remain the same at 0.10%.  As an example of what this looks like, see the following:

     4.15% inflation rate  +  0.10% fixed interest rate  =  4.25% yield

The above assumes an inflation rate closer to the historical average, but with all of the money being printed to bring us out of recession, it's plausible that we could be heading for another period of stagflation.  In the event that stagflation comes calling, an I Bond purchased today might look like this:

     10.65% inflation rate  +  0.10% fixed interest rate  =  10.75% yield

Now you know how this batch of I Bonds look today, during normal inflationary periods, and in a high inflation environment.  Note that the real return (ignoring taxes) will remain at the fixed interest rate of 0.10%.  This means that your purchasing power will pickup just one-tenth of one percent in real terms each year.  This isn't great, but for an emergency fund that has the ultimate in credit quality, it's a very good deal.

Taking all of this information into account, here's my recommendation:

• If you own I Bonds, keep them
• If you don't own I Bonds, keep your money in high yield bank savings and money market accounts until October.  If inflation picks up by then, make a small purchase into I Bonds so you can get familiar with them.  If inflation doesn't pick up by then, keep your money where it is.  To monitor inflation, click here.
• Long-term, don't forget about I Bonds.  This deflationary period is a very rare occurrence with our economy and should we go through a significant inflationary period, you'll be very pleased that you own them.

For more information on I Bonds, go to TreasuryDirect.gov.

Related Post:  Yield Update for November 2009 through April 2010

I Bonds are Almost Perfect

When it comes to stashing away an emergency fund, or as professionals call it, cash reserves, I Bonds are almost perfect for the task.  In a nutshell, I Bonds are U.S. government savings bonds that pay the rate of inflation plus a fixed amount of interest.  To put it another way, they have the highest credit rating in the world and will keep up with inflation over time--the perfect combination for an emergency fund.

Remember, the title says 'almost'.  The reason they're not perfect is that the rate of inflation is only measured twice a year resulting in rate changes in May and November.  Should the consumer price index be tame compared to the rest of the year, you may fall behind inflation.

The only other problem with I Bonds is that they do have some penalties for early withdrawal.  If you cash in these bonds within the first five years of owning them, you would forfeit the last three months' worth of interest, making them slightly less attractive to own as a primary holding in your cash reserves.  Since this is the case, you should use them only after you have substantial reserves in your traditional bank accounts or money market funds.

If you would like to learn more about I Bonds or want to purchase them, go to Treasury Direct.

Prognostications for 2009

In order to prepare you for the upcoming year, here is a list of my prognostications in seven key areas of personal finance for you to use in planning your money:

• Economy - the economy will begin its recovery in the latter part of 2009 with this recession coming to an end before March 31, 2010.
• Interest Rates - the Federal Reserve will hold rates steady for the first part of the year, and as the economy shows signs of stabilizing, will begin to raise rates near the end of the year.
• Inflation - with the global recession in full swing, inflation will remain tame for the entire year with only mild spikes in commodities prices.
• Deflation - a month or two of declining prices may occur, and these numbers are more likely to produce sensationalized headlines in the media than cause real duress for the economy.
• Stock Market - equities will lead the major asset classes with positive returns in excess of 10% for the year.
• Fixed Income Market - corporate bonds will lead the way as bondholders realize many of these bonds have been unfairly beaten down in the marketplace and double digit returns are not out of the question.
• Cash Equivalents - I bonds will continue to be the best place for cash equivalents with high yield FDIC insured bank accounts in second.

What this translates into is that the economy is going to recover meaning that job opportunities will begin to spring up toward the end of the year.  I always advocate improving job skills on a continuous basis through formal and informal education and training.  

In addition, if you've survived with your job intact during this recession, you may want to consder where you want to be when the next recession comes.  Do you want a change in career, a higher position in your company, start a new company, etc.?  Once you answer that, make a plan for your career over the next five years or more.

Interest rates are critical because they affect lending rates.  Since interest rates are at all time lows and should remain near these levels for the year, you should use fixed rate mortgages ONLY and try to eliminate as much variable rate debt as possible.  If you're living with variable rate debt, when interest rates increase in the coming years, you have the risk of being buried under interest charges.

Inflation that was a major concern prior to the financial meltdown last year will be relatively tame.  This means that there should be no hurry to make major purchases this year, even though companies will be pushing product at significant discounts throughout 2009.

Deflation is a somewhat rare occurrence in the United States, but if you take a look across the Pacific to Japan, you can see that it is a problem that has yet to be solved.  In Japan, they've had years of deflation and if you pull up a long-term chart of the Nikkei, you will be appalled at the sight of it.  We may have a small patch, but I have faith in the American consumer to get back to the old habit of spending.

The stock market should return 10% or more this year, but what's more important to understand is that we are near the bottom established in 2008.  This means that you should be contributing to retirement plans and other accounts and buying the market while it's still incredibly cheap.  In my estimation, staying on the sidelines is far riskier than buying the market at current levels.

Last year, many companies filed bankruptcy, leaving bondholders with virtually worthless junk bonds.  At the same time, good companies' bonds were unfairly beaten down and are priced very attractively.  As a result, once the economy shows signs of firming, these higher quality bonds will produce returns from their stated interest rates and through an increase in principal value.

I bonds remain very attractive through May 1st when the next interest rate change is scheduled, and under normal circumstances, they would likely lose out to high yield bank accounts.  However, since the Federal Reserve has reduced rates to near zero, I bonds should slightly outperform high yield bank products on balance for the year.

While these are only projections, I can tell you that it is far easier to see the bottom than it is to see the top.  When times are tough, fear seems to eventually dissipate into apathy, but when times are good, greed seems to have no limits.