Bonds help add diversity to your portfolio and control risk. But they can be complicated. We can help you understand the basics and make bonds work for you.
See Also: The Basics of Investing in Bonds
If it's yield you're after, you'll never be happy with savings bonds. Other factors usually motivate buyers.
Savings bonds are backed by the U.S. government. Payment of the interest and principal is guaranteed. Lost, stolen, damaged, or destroyed bonds can be replaced free. Savings bonds are not transferable, meaning you can cash them in but you can't sell them to someone else. Their market price doesn't rise when interest rates fall or fall when rates rise. Savings bonds will never have to be cashed in for less than you paid for them.
Convenience (Sort Of)
Payroll savings plans sponsored by employers make it easy to accumulate savings bonds. Savings bonds can also be easily purchased at banks and other financial institutions. It's not quite so easy to redeem savings bonds. When that time comes, try a full-service bank or financial institution. You'll have to sign the request for payment on the back of the bonds in the presence of a certifying officer at the bank, provide your Social Security number and mail the bonds to the Federal Reserve Bank that services your area.
The interest is exempt from all state and local income taxes. And although the exemption doesn't extend to federal taxes, your options for paying the federal tab create opportunities to increase your effective return considerably.
For example, parents who want to start a college fund can purchase bonds in their child's name. Because the child probably won't have enough income to incur any tax liability for several years, the income from the bonds will accumulate, for practical purposes, tax-free.
Types of Savings Bonds
Savings bonds come in three varieties: EE bonds and I bonds, which are vehicles for savings, and HH bonds, which were created to produce income for their buyers.
EEs purchased today pay a fixed rate of interest, which will apply for the 30-year life of each bond, including a ten-year extended maturity period (unless a different rate or rate structure is announced and applied at the start of the extension period).
Interest is compounded semiannually, with a three-month interest penalty if you cash in the bonds before five years. Rates for new bonds are set May 1 and November 1, with each new rate effective for all bonds issued through the next six months. You can get current rate information at savingsbonds.gov. EE bonds are sold at a 50% discount from face value in denominations of $50, $75, $100, $200, $500, $1,000, $2,500, $5,000 and $10,000.
The interest paid by I bonds actually comes in two parts: an underlying fixed rate, which is announced when the bonds are issued, plus a second rate that is equal to the level of inflation. The interest is compounded semiannually. You must keep bonds for at least one year before you can redeem them and at least five years if you don't want to forfeit three months of accrued interest. They will earn interest for 30 years.
I bonds sell for face value right from the start. Denominations start at $50 and climb to $10,000. The maximum you can purchase in one year is $30,000.
Potential savings-bond buyers shouldn't be put off by the relatively low fixed rate paid by I bonds. Consider them an inflation hedge and think of them this way: With a fixed rate of 1.5% and low inflation, your return will be low, but you'll still be beating inflation by 1.5%. If inflation soars to, say, 10%, the return on your I bonds will be 11.5%. Feel better?
The Bureau of the Public Debt stopped issuing HH bonds in 2004, citing the high cost and relatively few takers. Bondholders who exchanged E or EE bonds for HH bonds before the deadline will earn interest on HH bonds until they reach final maturity in 2024.
With so many different interest-rate schedules, it is often difficult to figure out what your bonds are worth, particularly if you've been buying them for several years. For help with this, use the Savings Bond Wizard on the Bureau of the Public Debt's Web site.