Money Talks: Series I Jump While Patriot EE's Slump

By: Stacy Johnson
By: Stacy Johnson

Uncle Sam's fixed-income offerings, like the inflation-fighting I bonds and the Patriot EE bonds get their six-month rate review.

And at first glance, the newer I bond looks like the better deal. But the EE has a track record of 2.55 percent over inflation.

What do you do now? And what do you do in six months when new rates are announced?

The I bond looks a whole lot better now that its composite rate shot up to 4.08 percent. It had been pegged at 2.57 percent the previous six months.

Another popular savings bond, the Series EE Patriot bond, saw its rate decline nearly three-quarters of a percentage point.

I bonds are government savings bonds that are designed to make sure your return doesn't lose out to inflation. Bonds purchased between now and the end of April 2003 will earn a fixed rate of 1.6 percent and an inflation premium of 2.48 percent. I bonds are re-priced by the Treasury Department every May 1 and Nov. 1.

But even though at first blush it seems as though the new rate is a big improvement over the previous rate, the drop in the fixed rate to 1.6 percent from two percent is a concern.

"The reason it's significant is the fixed rate stays with the bond for the life of the bond. It's the spread you'll always get with the inflation component," said Dan Pederson, president of BondHelp.com and author of "Savings Bonds: When to Hold, When to Fold and Everything In-Between."

"The first three years of the I bond's life, we saw fixed rates in the three-percent to 3.6-percent range. Folks that got those bonds are in a very good situation. They retain those rates for the life of the bond. But in Nov. 2001 we saw the biggest drop in fixed rates, from three percent to two percent. This 1.6 percent is a new low-water mark," Pederson said.

That's not a reason to hold off on buying an I bond. The 4.08 composite rate is more than a half percent better than the national average on five-year CDs, and more than a couple points better than the national average on one-year CDs.

The question, says Pederson, is whether to cash the 1.6 percent bond six months from now if the new fixed rate rises.

"If you're a long-term holder, there's a strong case for re-buying at the higher rate if they bump it up down the road. If you have one at 1.6 percent and it goes to 2.5 percent, I'd cash it in. The three months' interest penalty would be insignificant compared to the gain," said Pederson.

You'll pay three months' interest penalty if you cash an I bond in less than five years. You'll also have to pay federal tax on the gain. I bonds are not subject to state or local tax.

For more information, read this story about how I bonds work.

The other bond that is re-priced on the same six-month timetable as the I bond is the Series EE Patriot bond. Its new interest rate is 3.25 percent, down from 3.96 percent.

The Patriot's interest rate is 90 percent of the average yield of five-year Treasury notes for the preceding six months. If you buy a Patriot between now and the end of April 2003 you'll get 3.25 percent for six months from the time you purchase the bond. After that you'll get the new rate that is announced every six months in May and November.

Don't automatically assume the I bond is a better investment than the Patriot just because it has a higher rate for the next six months.

"The deceptive thing about these numbers is it looks like the I bond is a better deal. But over the past 12 years, the Patriot has averaged about 2.55 percent over inflation. So, if the Patriot holds to that trend then it may, over the long haul, be the better buy," Pederson said.

Patriot bonds are bought at one-half the face amount of the bond. In other words, you'll pay $500 for a $1,000 bond. You receive the full face value if you hold the bond until maturity. Bonds increase in value every month and interest is compounded semiannually. Patriot bonds can be bought in denominations ranging from $50 to $10,000.

Both I bonds and Patriots have a 30-year life. You have to hold them for six months. As with the I bond, if you cash a Patriot in less than five years, you'll forfeit three months' interest.


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