The Basics of Savings Bonds

Worldwide Invest Better Day 9/25/2012
Worldwide Invest Better Day 9/25/2012

The Motley Fool has been helping ordinary people become better investors for nearly two decades. This month, we're reaching out to millions of investors to help guide them in their quest toward financial knowledge and independence.

Along those lines, I've explored a range of different areas of the investing world. Historically, many savers used savings bonds as a simple way to set money aside for the long run. But with interest rates as low as they are right now, are savings bonds really a viable investment? Today, we'll take a look at how savings bonds work and whether they're a smart move.

The ultimate long-term investment?
Savings bonds have become a key part of American history, largely because of their role in financing U.S. war efforts in both World Wars. But for investors, savings bonds live on as a way of building long-term savings.

You can buy two different kinds of savings bonds. Series EE bonds pay a fixed interest rate for the first 20 years that you own them. Series I bonds, on the other hand, pay an interest rate that changes every six months based on moves in the price-tracking Consumer Price Index, a measure of inflation. That makes Series I bonds look more like the Treasury's inflation-protected securities, which iShares Barclays TIPS Bond (NYS: TIP) and other ETFs offer investors.

Savings bonds are pretty flexible as a savings vehicle. You can redeem them at any time after holding them for at least one year, but they'll keep earning interest for up to 30 years. You'll forfeit three months of interest, however, if you turn in your bonds during the first five years after you buy them.

Unfortunately, Series EE bonds aren't terribly competitive. The current rate of 0.6% is less than you can get even from some bank savings accounts, with Discover Financial (NYS: DFS) and Sallie Mae (NAS: SLM) offering 0.8% and 1% respectively. MetLife's (NYS: MET) banking division, which it has tried to sell off to General Electric's (NYS: GE) GE Capital division, offers a savings account with a 0.85% rate. And although those rates aren't guaranteed not to fall further, it's hard to imagine them dropping too much more from here.

But Series I bonds offer more potential. Even with no extra interest above the rate of inflation, Series I bonds currently pay 2.2%. And with some believing that inflation will heat up, Series I bonds likely offer you better value than their Series EE counterparts.

Learn more
You can get a lot of valuable information from the Treasury's new website on savings bonds, which you can access here. Also, check out the Fool's 60-Second Guide to Short-Term Savings to learn more about all your savings options.

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Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy likes giving you the basics.

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