Savings Bonds: EE-I, EE-I, Oh!

Once thought of chiefly as a haven for scaredy-cats and an obvious gift for kids' birthdays and bar mitzvahs, savings bonds have been finding their way into serious investors' portfolios since the government floated interest rates in the early 1980s. Today, savings bonds offer competitive yields, unquestioned safety and some unique tax features that make them especially suited for savers with an eye on college costs or retirement some years away.

Savings bonds are protected against default by the full faith and credit of the U.S. government. The only way you can lose the principal is to lose the bond, and if you do lose the bond (or if it is stolen or destroyed), you can get it replaced by completing form 1048 and mailing it to the Bureau of the Fiscal Service, P.O. Box 7012, Parkersburg, WV 26106-7012

Through the years, an alphabet of savings bonds have been issued, and while some of these bonds may still be gathering interest, they are no longer available for purchase. Today, investors can only buy series EE and I bonds. Here's how they break down:

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EE bonds are sold for half of face value in denominations ranging from $50 to $10,000 for paper bonds -- bonds bought online are sold for face value ranging from $25 to $30,000. EEs earn a fixed rate of interest for 30 years. Rates for new issues are adjusted twice a year, in May and November, with each new rate effective for all bonds purchased over the next six months. EE bonds pay all of their accrued interest when they are redeemed.

The interest paid by I bonds actually comes in two parts: You get an underlying fixed rate, which is announced when the bonds are issued, plus a second rate that equals the level of inflation. For example, if the flat rate is 3% and inflation is 2%, then I bonds would pay 5% that year. Potential 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 3% and low inflation, your return will be low but you'll still be beating inflation by 3%, year after year. If inflation soars to, say, 10%, the return on your I bonds will be 13%. Like EE bonds, I bonds earn interest for 30 years and pay that interest when the bonds are redeemed.