U.S. savings bonds were born in the Great Depression, helped win World War II, and underwrote college degrees for countless people. Yet, in the investing world, they’re largely an afterthought, considered a dusty relic from a bygone era.
Still, savings bonds are very much alive, and they can be a viable (if limited) component of an investor’s long-term plans. Backed by the “full faith and credit” of the U.S. government, savings bonds are about as low risk as investments get, because Uncle Sam is unlikely to default on debt.
In other words, there are both symbolic and practical reasons behind the tradition of grandparents purchasing savings bonds in a grandchild’s name. A couple of decades later, that money, plus interest, should be there for the kid.
“It all comes down to safety,” Robert Siuty, senior financial consultant at TD Ameritrade, says of savings bonds. “How safe do you want your investment to be, and how predictable do you want your investment to be?”
So, what’s the story with savings bonds? Here’s a brief primer.
What Are Savings Bonds?
U.S. savings bonds are non-marketable, long-term debt securities (typically maturing in 15 to 30 years) issued by the Treasury Department to help pay for the government's borrowing needs. These bonds can be purchased at “face” values ranging from $25 to $10,000. At the end of September 2017, the value of all unredeemed savings bonds totaled $161.7 billion (out of the government’s $14.7 trillion of total public debt outstanding), according to the U.S. Treasury Dept.
What’s the History?
Savings bonds as we know them were created in 1935, when President Franklin D. Roosevelt signed legislation authorizing the U.S. Treasury to sell the securities. The goal: to encourage broad public participation in government financing, according to TreasuryDirect. Early versions were tailored toward smaller investors. Known as “baby bonds” or “defensive bonds,” they were sold in denominations from $25 to $1,000.
“War savings bonds” became a common name for the securities following Japan’s attack on Pearl Harbor in 1941, because the money raised by the bonds went directly toward the U.S. war effort.
How Do Savings Bonds Work?
A Series EE bond, one of two types currently issued by the Treasury, can be purchased at face values ranging from $25 to as much as $10,000, and it will earn an annual fixed rate of interest for 30 years.
The bond’s interest is compounded semiannually, which means that twice a year, all interest the bond earned in the previous six months is added to the main (principal) value of the bond. Interest in the next six months is then earned on the new value. In month 7, you earn interest on the original price, plus six months of interest.
This deferred, yet effectively guaranteed, payout structure is one reason savings bonds have been popular gifts for infants or young children. Bonds can be purchased through the government’s TreasuryDirect electronic platform (you also must be an American citizen, with a social security number, to make a purchase). Savings bonds are not available to purchase through TD Ameritrade.
What Kind of Rates Do Savings Bonds Pay?
Not much. Series EE bonds issued from November 2017 through April 2018 will earn an annual fixed rate of 0.10%. Series I savings bonds, the other current version, will earn a composite rate of 2.58%, a portion of which is indexed to inflation (based on the Consumer Price Index) every six months. Both bonds have an interest-bearing life of 30 years.
At such paltry rates, “there's not a whole lot of appeal” for investors, said Greg McBride, Chief Financial Analyst at Bankrate.com. However, interest on savings bonds is subject only to federal tax, not state or local taxes, and if proceeds are used toward certain qualifying education expenses, you may not have to pay federal tax.
Rates on savings bonds were 6% to 7% during the 1980s and above 4% as recently as 1996. But rates sank in the 2000s as the Treasury adjusted to lower inflation.
“It’s conceivable that the appeal of savings bonds could get better, if interest rates rise. But that’s up to the Treasury,” McBride says. From the standpoint of the taxpayer, this makes sense: “You don't want the Treasury to overpay for its borrowing,” he adds.
Why Buy a Savings Bond for a Child (or Myself)?
Because it’s a fixed-income instrument that typically doesn’t carry the volatility of the stock market, savings bonds can still be relevant for today’s investors, Siuty says. On the flip side, fixed-income instruments also lack the potential capital appreciation of equities.
Savings bonds, like other investments, should be approached in the context of risk appetite and potential overall returns.
“Look at it as a piece of an overall investment puzzle,” Siuty says. “Some people prefer fixed income because they like that predictability” of returns, he says. “Ideally you want to keep up with inflation, if not outpace it. You want to protect the purchasing power of your money.”
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
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