Monday, April 24, 2006

I-Bond Yield at 6.73%: Not the Whole Story

One of the safest places to invest money is to invest in US Government bonds. These low-risk investments come at a price that is a general rule to apply to all investments; the lower the risk, the lower the expected return. Wait a minute... what about the current 6.73% yield on I-bonds? This surely blows away any bond yield that is available at this low risk level. But let's look at it closer as this yield is set to expire at the end of this month.

The yield on I-bonds is comprised of two rates: a fixed rate that is good for the life of the bond (30 years) and a variable semiannual inflation rate based on the consumer price index (CPI). Knowing the fixed rate is key because this is the true yield of the bond. For example, the prior 6 months had a relatively high CPI of 2.85%. Multiply by 2 to make it the annual yield (i.e. 12 months) and that results in 5.7%. Finally, add the fixed yield of 1% with some minor adjustments and you arrive at the current yield of 6.73%.

Now, a new yield for I-bonds will occur May 2006 and while we can't predict what that rate is; we can make an educated guess. The CPI for the last 6 months has been ~0.5%; annualize this brings you to 1%. Add this to the fixed rate and your new I-bond yield will be around 2%...still a positive return but definitely not the 6% that you may have expected upon first signing up for the bond.

Of course, I-bonds still definitely have a role in everyone's portfolio as they are a nice hedge against inflation. I allot 25% of my bond portfolio to TIPS (Treasury Inflation Protected Securities) which for my current allocation (90% stock/10% bonds) is 2.5% of my overall portfolio. But it's important to understand how the yield for I-bonds is calculated so that you don't expect the nice return of 6.7% for the life of the bond.
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3 Comments:

Blogger Wanda said...

Hi,

Thanks for being my first visitor! I have a friend at UC San Diego - the scenery is beautiful, but the housing prices are not. I think she pays about almost $1000/month for a shared room in an apartment.

11:10 PM, April 24, 2006  
Blogger Wanda said...

Hi,

Thanks for being my first visitor! I have a friend at UC San Diego - the scenery is beautiful, but the housing prices are not. I think she pays about almost $1000/month for a shared room in an apartment.

11:11 PM, April 24, 2006  
Anonymous Anonymous said...

*sigh* Still got the moderator tags on.

No links for you!

http://www.gotwavs.com/cgi-bin/tvmp3s.cgi?Seinfeld=sfsoup.mp3

2:30 PM, April 26, 2006  

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