By MARY DEIBEL
Scripps Howard News Service
May 09, 2005
Washington - Savings bonds have been a favorite way to blend gift-giving, tax-wise investing and patriotism since FDR went on the radio 64 years ago to order one in advance of America's entry into World War II.
But Uncle Sam attached new strings last week to Series EE savings bonds that have long been favorite gifts for new babies, tax-advantaged stocking stuffers for the college-bound or automatic payroll savings for home and retirement nest eggs.
Series EE bonds for the first time pay a fixed interest rate, set at 3.5 percent for 30-year EE bonds bought over the next six months, with a new rate set for new issues in November and every six months thereafter.
The rate paid by an EE bond when you buy it will be the rate it bears for its 20-year "original maturity." EE bonds also have a 10-year "extended maturity" during which the U.S. Treasury may or may not change the rate.
"This is not a good thing," says Jack Quinn, CEO of SavingsBonds.com, an online bond information site. "Once you get a fixed rate, you're stuck."
Until now, EE bonds carried a fluctuating rate that was adjusted to market changes every six months, which made them a popular choice for risk-averse but inflation-wary investors.
Series EE bonds issued before May 1 will continue to have interest rates adjusted every six months, with the rate set Monday at 3.42 percent through October. Interest on EE bonds, old or new, remains exempt from state and local income tax, and federal tax continues to be deferred until the bonds are sold.
But with consumer prices up 3.1 percent the last year, including a hefty spike in March because of sharp gasoline and energy price rises, investors have good reason to question the wisdom of locking in a savings bond interest rate for 20 to 30 years.
In response to that inflation fear, the Federal Reserve's Open Market Committee ratcheted up the key interest rates banks charge each other for overnight loans a quarter percentage point to 3 percent, marking the eighth Fed rate hike since June.
The central bank repeated its promise since then to increase rates at a "measured" pace even though "pressures on inflation have picked up in recent months and pricing power is more evident."
For people unwilling to risk investing in volatile stocks or interest-sensitive bonds, the good news from the Fed is that returns on cash accounts, including large Treasury bills and bank certificates of deposit, will likely continue to rise.
But the key question for savvy investors is: Where will the economy go from here?
"The whole world thinks interest rates will soar, but what if they don't? What everyone believes doesn't always come true, so it's important to diversify," says Barry Glassman, first vice president of Cassaday & Company, a McLean, Va., financial planning and investment management firm.
He advises clients to diversify their holdings to fit three economic scenarios:
Series I inflation-adjusted bonds aren't affected by EE bond fixed rates.
I bonds are available electronically for as little as $25 and in paper form for $50 or more. They can be bought through banks, credit unions and some payroll savings plans and - in electronic form - through www.treasurydirect.com.
I bonds bought between May 2 and Oct. 31 will pay 4.8 percent interest the first six months of their issue, including a bumped-up 1.2 percent fixed rate of return plus a 3.58 percent annualized rate of inflation, with another adjustment scheduled for Nov. 1.
As with EE bonds, you cannot cash in I bonds for the first year, and you lose three months interest if you redeem them before five years.
Dan Pederson, president of the Savings Bond Informer, a savings bond consulting service, hasn't given up on EE bonds even though he says that short-term bond buyers are better off buying Series I bonds for a year or two and taking the three-month penalty.
"Longer term it's a tougher call between Series I and Series EE bonds," he says. "Should EE bond fixed rates rise above 4 percent, investors who look to hold onto their bonds at least five years may benefit by cashing in their 3.5 percent EE bonds for the higher fixed rate EE series."
One more benefit is that fixed-rate EE bonds don't suffer interest rate risk, which can cause other bonds to lose value when interest rates rise and can cost you big time if you must sell before the bond matures for far less than you paid in the first place.
With savings bonds, Uncle Sam guarantees you get what you paid plus interest.