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The Honolulu Advertiser
Posted on: Thursday, April 22, 2004

Savings Bond buyers might want to wait until May

By Sandra Block
USA Today

Bad news is relative. A drought-stricken farmer will welcome a rainy forecast, but it's terrible news for a parent hosting a birthday barbecue for 25 toddlers.

The same is true of interest rate forecasts. The prospect of higher rates horrifies borrowers and stock investors. But millions of people who rely on income from certificates of deposit and money market mutual funds would love an end to record-low rates.

Unfortunately for interest-starved savers, many economists don't expect the Federal Reserve Board to raise interest rates until later this year. That means CDs and money market funds will continue to gather dust for a while. But savers have one shot at higher rates before the Fed acts: the semiannual rate adjustment for Savings Bonds, effective May 1.

For investors in traditional EE Savings Bonds, the outlook isn't great. The EE Bond rate is tied to five-year Treasury notes, and probably won't change much from the current 2.61 percent, says Dan Pederson, author of "Savings Bonds: When To Hold, When to Fold and Everything In-Between." The five-year T-note yield hasn't moved much since the last adjustment.

But the rate on inflation-adjusted I Bonds could rise to as high as 3.4 percent from the current rate of 2.19 percent, Pederson says. I Bond rates are based on two components: a fixed rate, which stays the same over the life of the bond and is now 1.1 percent, and a variable rate tied to the consumer price index. The variable rate may be adjusted every six months.

The expected rise in I Bond rates reflects increases in prices for energy, clothing and other goods. The CPI jumped 0.5 percent in March.

If a 3.4 percent rate sounds good to you, wait until after April 30 to buy your I Bonds, Pederson says. If you buy before then, you'll get the current rate of 2.19 percent until October, when your rate will be adjusted to the level announced May 3 (the rate is usually posted May 1, but that's a Saturday this year). If you wait until May to buy your bonds, you'll get the new rate for the next six months, Pederson says.

There's a risk to this strategy. The Treasury sets the fixed rate on I Bonds. If it lowers the fixed rate, investors who buy after May 1 will get stuck with the lower rate for the life of their bonds. Investors who buy before April 30 will lock in the 1.1 percent rate for as long as they hold their bonds.

But another reduction in the fixed rate is unlikely, Pederson says.

Whichever bond you choose, don't invest money you'll need in a few months. You're required to hold Savings Bonds for at least a year. If you cash out in less than five years, you'll pay a penalty equal to three months' interest.