New rate set for series I savings bonds

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Every six months, the Treasury sets a new fixed rate for series I savings bonds.  After tracking close to the rate on the Treasury's other inflation-indexed bonds during the Clinton administration, the rate was cut sharply starting in 2001, culminating in an interest rate of zero for the past six months.  Today, though, the Treasury announced the new rate for the next six months:  0.7%

That rate isn't as bad as it sounds, because you get that plus inflation.  Adding in the adjustment for inflation, the total annual return on a bond purchased this month will be 5.64%.  (That's an annual rate that will apply for the next six months.  A new rate, based on inflation, will be calculated every six months--but the 0.7% fixed part of the return will remain in effect for the life of the bond.)

There are several good features of the I Bonds.  You can defer taxes on the interest until you cash the bond--up to 30 years.  And, if you use the money for education expenses, you may not have to pay taxes on it at all.  In addition, if there's deflation, your investment is protected to the extent that its value won't fall below the face value of the bond.

As an alternative to the series I savings bond, consider TIPS--Treasury Inflation Protected Securities.  They pay a market rate determined at auction, rather than a fixed rate determined by the Treasury.  Currently, they're paying as much as 3.25% (plus inflation).  Obviously, that's a lot better than 0.7%.  There are several downsides, though.  In particular, new bonds are only issued on specific dates (although you can buy one at any time through a broker).  Also, TIPS have a specific maturity date, and you can neither cash them in early nor hold them longer, the way you can with a series I savings bond.  In addition, their protection from deflation isn't quite as good.  (For more info, see my previous article about TIPS and I Bonds, and for information on the mechanics of buying them, see my article Treasury bills for ordinary folks.)

Inflation plus 0.7% isn't a great rate, but given that there's a real danger of the economy tipping toward either inflation or deflation (or first one and then the other), these bonds may be a good buy.