The lowly Series EE Savings Bond is a misunderstood and completely ignored investment. And that's a shame, because if purchased with surety that you can hold it for 20 years, it is a powerhouse of super-safe investments.
But one thing: if you agree with me and are considering buying EE bonds in 2016 (the limit is $10,000 per person per year), you should do it this week, before the Treasury's May 2 rate reset.
Why they look horrible. EE bonds come with a fixed rate, which never changes through the life of the bond. Through April 30, that fixed rate is 0.1%. Yeah, 0.1% for up to 30 years. Most people who look at EE bonds see that one fact and dismiss them.
Why they aren't horrible. When you purchase EE bonds, you are buying them at half their face value, and they reach their full face value in 20 years. Here is the Treasury's explanation:
EE Bonds issued on and after May 1, 2005, will reach original maturity at 20 years. These bonds also are guaranteed to double in value from their issue price no later than 20 years after their issue dates. This is the bonds' original maturity. If a bond does not double in value as the result of applying the fixed rate for 20 years, the Treasury will make a one-time adjustment at original maturity to make up the difference.
In other words, you collect a miserable 0.1% for 20 years, and then the Treasury automatically adjusts your principal to double your original investment. Your $10,000 original investment becomes $20,000. And at that point, you sell the EE bond.
Doubling after 20 years means EE bonds effectively pay 3.5% interest. This is wildly generous in a market where a 20-year Treasury is yielding 2.30% and a 30-year Treasury is yielding 2.70%. EE bonds are equally safe and have the benefit of tax-deferred income.
Even if you are worried about inflation protection and prefer TIPS and I Bonds, EE bonds can be a sensible addition to your super-safe asset allocation. Take a look at this chart showing after-inflation returns:
The blue area shows that the EE bond outperforms all the other options up to average inflation of 2.5%. At that point and above, the 20-year TIPS outperforms all other investments. The EE Bond outperforms the I Bond up to an inflation rate of 3.0%, and just barely under-performs at 3.5%.
Let's say you are 42 years old and planning to retire at age 62. You could begin buying $10,000 a year in EE bonds now, and at age 62, you'd have $20,000 a year in tax-deferred income for 20 years. Or if you have a new baby, you could buy $10,000 a year in EE bonds for 4 or 5 years and have $20,000 a year for college costs 20 years down the line. (EE bond proceeds used for education costs are federally tax-free, up to certain income limits.)
The only issue with EE bonds is your ability to hold them 20 years. If you are sure you can, then they are a good, sensible addition to your super-safe asset allocation.
But why buy now, before the May reset?
While the Treasury now seems very reluctant to change the terms of EE bonds, the doubling after 20 years is out-of-market generous. The Treasury hardly ever gets out-of-market generous, and so I think there's a slim possibility that the EE bond terms could change with the May 2 reset announcement.
For example, the Treasury could stretch out the doubling period to 25 years (resulting in a return of about 2.8%) or even 30 years (a return of about 2.3%).
I don't think that will happen, but it has happened many times in the past. For example, I own EE bonds issued in 1992. The terms for new EE bonds have changed three times since then.
- Back in 1992, EE bonds paid 6% a year and were guaranteed to double in 12 years. After 12 years, they reverted to paying 4% a year to maturity.
- In March 1993, the doubling term was adjusted to 18 years.
- In May 1995, it was adjusted 17 years.
- In June 2003, it was brought to 20 years, where it has remained.
The fact that the Treasury hasn't changed the doubling term in 13 years is good evidence that it won't do it on May 2. But just in case, if you are ready to buy EE bonds in 2016, do it this week, before Friday.
Disclosure: I own individual TIPS, but no mutual funds.
Tipswatch
I am no longer writing for this site. More details. I will continue to post updates at my site, TipsWatch.com.-----David Enna is a long-time journalist based in Charlotte, N.C. A past recipient of two Society of American Business Editors and Writers awards, he has written on real estate and home finance, and was a founding editor of The Charlotte Observer's website. The Tipswatch blog, which launched in April 2011, explores ideas, benefits and cautions about U.S. Series I Bonds and Treasury Inflation-Protected Securities, which David believes are an under-appreciated and under-used investments. David has been investing in TIPS and I Bonds since 1998.
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