Understanding Savings Bonds Rates
Savings bonds are a great way to round out an investment portfolio or earn guaranteed passive income, and understanding savings bond rates will help you make the most of the investment. To newcomers and seasoned investors, however, the rates behind popular government savings bonds are not always easy to understand.
Fortunately, it doesn't take a PhD in Finance to learn how savings bond rates work. By looking at the fixed and inflation rates, you may even be able to make a reasonable guess at where bond rates are going, allowing you to time your buying and selling more effectively.
About Popular Bonds, I-Bonds and EE Bonds
I-Bonds are by far the most popular savings bonds available from the United States Treasury. These investment vehicles are meant to be held for an intermediary period. This means at least five years before you can sell them without incurring a penalty that reduces your earnings from the interest accrued. I-Bonds determine their interest from both the fixed and inflationary rates.
EE Bonds are another popular option available from the US government. These are intended as long term securities, and many EE Bonds are held for twenty years or more, a point where their value is at least doubled. They utilize a fixed rate set by the Treasury.
Understanding the Fixed Rate
The fixed rate of return is established by the highest levels of the US Treasury Department. It's normally determined and, if needed, adjusted between May and November of each year, with alterations announced at the start of those two months. Several important economic measurements factor into how the Treasury determines fixed rates.
Trends in Treasury Notes, another type of fixed investment instrument sold by the government to individuals, private entities, and other governments, is an important factor in adjustments to the fixed rate. The demand for these notes on the market generally determines their rate. The higher the demand, the higher the rate, and vice versa.
Fixed rates also tend to follow other interest rates affecting the economy, such as prevailing rates on loans set by monetary policy. Since 2008, rates on all savings vehicles and loans have been at historic lows, and this extends to fixed rates on Treasury bonds as well.
Understanding the Inflation Rate
The inflation rate is another important component of savings bonds, particularly I-Bonds. The inflation rate is set by the Treasury in response to the rate of inflation or deflation occurring throughout the economy. Consumer Price Index (CPI) measurements are used to observe inflationary effects.
CPI trends indicating higher consumer prices means inflation is up, and this increases the inflation rate on I-Bonds. The opposite is equally true, but the Treasury guarantees that in a deflationary environment with negative growth, you won't get a negative interest rate, just a very low one.
Although there is no certain way to predict where interest rates will land, you can get an idea of where the inflation rate is heading in the future by closely following CPI measurements. High growth means rates will probably increase the next time an adjustment is due.
By demystifying how savings bond rates work, you can make smarter decisions. These bonds are virtually impossible to lose money on, but aiming for a higher interest rate is always a wise goal.
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