U.S. savings bonds, that tried-and-true gift of grandparents to youngsters who might rather have a new bicycle for their birthday, aren’t looking that appealing these days as low interest rates continue. But they still have a few features worth considering for those who want to bulk up the safe-haven portion of their portfolio.
Gone are the days when you can earn 5 percent interest on new bonds, as new savings bonds are earning as little as 0.1 percent. Also, they are no longer sold at a discount to their face value by the government. However, they remain one of the few places to put your money that is backed by the full faith and credit of the U.S.
“We are the safe haven of the world,” says Karissa McDonough, fixed income strategist at People’s United Wealth Management, part of People’s United Financial in Bridgeport, Connecticut.
One attractive feature of savings bonds, unlike Treasurys, is that you don’t have to pay taxes on them until you cash them in, McDonough says.
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Also, the interest may not be subject to federal income tax if the bonds are used for qualified higher education costs, says Kathy Williams, senior vice president and senior wealth strategist for Waddell & Associates in Memphis, Tennessee.
Bonds to consider. There are two types: EE bonds, which earn a fixed interest rate set at the time of purchase, and inflation-protected I bonds, which earn the fixed interest rate plus an inflation rate calculated twice a year, Williams says.
They can be redeemed any time after one year, but cashing them in before five years forfeits three months of interest. Each stop paying interest after 30 years. EE bonds are available electronically via TreasuryDirect.gov, while I bonds can also be bought through income tax refunds. Interest is earned monthly and compounded twice a year.
McDonough recommends sticking with EE bonds. “It’s hard for me to see inflation picking up substantially,” she says.
How to diversify a portfolio with savings bonds. McDonough says her firm is positioning clients more defensively in anticipation of continued volatility in capital markets, meaning she is more in favor of safer assets such as savings bonds.
For investors with a portfolio comprised of 60 percent stocks and 40 percent bonds, McDonough recommends that a fourth of the bond holdings should be in safe havens such as savings bonds, Treasurys and certificates of deposit.
Williams says a good rule of thumb is for dual income families to have three months of living expenses on hand in cash or cash equivalents, or six months in single-earner households. After owning them for a year, savings bonds can be considered a cash equivalent, she says.
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James Sanford, founder and portfolio manager with Sag Harbor Advisors, recommends keeping even more in cash, depending on what kind of job you have. Doctors or others in relatively stable fields can get away with only one year of expenses saved in cash, while some in more volatile professions such as finance should hold upwards of two years in savings, he says.
That’s frustrating for investors because cash doesn’t earn much these days, he says.
Know the risks. One risk to buying savings bonds now would be the opportunity costs of missing out on other types of investments, McDonough says.
“Interest rates are extremely low right now, and you can generally get the current rate of interest (at least the fixed amount) or more from a bank, so for many people savings bonds aren’t appealing,” Williams says.
Sanford points to some online-only banks offering around 1 percent interest on regular savings accounts. Because these are also backed by the U.S. government through the Federal Deposit Insurance Corp., these are superior to savings bonds, which lock up money at currently low interest rates, he says.
According to Williams, the biggest mistake people can make with savings bonds would be to invest in them and then need the funds before one year.
“While most Americans purchase savings bonds for retirement or education purposes, the reality is that most bond owners wind up cashing them earlier than they expected to pay for other, often unforeseen expenses, such as bills, home or car repairs, or a vacation,” according to SavingsBonds.com, a non-governmental website that values savings bonds.
Another mistake would be to automatically sell the oldest bonds, which may actually be earning the highest interest rate, according to the website. Bonds can also be worth more than the amount printed on the face of the bonds, leading investors to cash in more bonds than needed, resulting in a bigger tax hit than expected.
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Also, bond holders looking to cash in should make sure to not do it just prior to one of the six-month interest posting dates.
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How to Buy U.S. Savings Bonds originally appeared on usnews.com
