U.S. savings bonds have been a time-honored method of accumulating wealth for middle class families. They are simple to buy and redeem and are also backed by the full faith and credit of the U.S. government. But these hallowed financial instruments have slowly evolved over the years, and, unfortunately, most of it hasn’t been for the better.
It might seem like an absurd suggestion, but U.S. savings bonds have a dirty, secret history. For the past 15 years, the U.S. Treasury has been systematically degrading the attractiveness of these traditional financial vehicles. As a result, it is very difficult to recommend them as anything other than a cash-substitute in certain niche financial situations. If you really want to make money, or even just preserve your purchasing power, you will need to redeem your savings bonds and roll the proceeds into better investments.
Let’s start at the beginning. The history of U.S. savings bonds stretches back to the Great Depression. In 1935, President Franklin D. Roosevelt approved a law that allowed the U.S. Treasury to issue small denomination government bonds, sometimes called “baby bonds”, directly to the American public. The government paid a very generous (for the Depression years) 2.9% interest rate on these initial notes.
The U.S. savings bond program remained relatively small until World War II, when the federal government’s financing needs skyrocketed. As a result, the popular Series E bonds were introduced in 1941. These fixed rate financial instruments were purchased and held by millions of households during and after the War. From the 1940s until the 1970s, savings bonds almost always paid an interest rate that was comfortably higher than inflation.
In 1980, Series E notes were phased out and replaced by Series EE bonds. Series EE savings bonds, which are still being issued today, earn either a fixed or variable rate of interest, depending on their issue date. They pay no interest outright, but instead accrue interest like a zero-coupon bond. Series EE savings bonds were traditionally sold for half of their face value, with a $100 bond selling for $50. They are guaranteed to accrue to face value by the end of their original maturity, which is currently 20 years from the date of issue.
The other type of U.S. savings bond currently being issued is the Series I bond, also known as I-bonds. The interest rate for these notes is based on the inflation rate as measured by the CPI (Consumer Price Index) plus a fixed “real” (after-inflation) interest rate. Series I bonds were first issued in 1998 and, like Series EE bonds, accrue and compound interest until redemption.
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Now this is where things get interesting. In 2003 the minimum holding period for both EE and I-bonds was increased from a reasonable 6 months to a rather unreasonable 12 months. The U.S. Treasury supposedly changed this rule to prevent retirees, children, the frugal and other unrepentant savers from arbitraging the interest rate differential between savings bonds and short-term debt instruments! As the U.S Treasury arrogantly stated, “Savings Bonds are designed to be a long-term savings vehicle.” Just to drive home its point, the U.S. government also penalizes you three months worth of interest on any savings bond you redeem that is less than 5 years old.
And while the U.S. Treasury claimed that savings bonds are for the long-haul, their actions indicated otherwise. From 1997 to 2005, Series EE savings bonds earned only 90% of the prevailing 5 year U.S. Treasury note’s interest rate. It’s a very raw deal to give your valued “long-term” savers a subpar 90% of the lower interest rate 5-year bond, when the U.S. government could have easily paid 100% of the higher interest rate 20 or 30-year Treasury bond! Unfortunately, this was a portent of worse things to come for long-suffering savings bond investors.
Then we fast forward to 2005, when the Treasury changed the terms on EE bonds from the old, floating rate model to a new, fixed rate one. At first, this new fixed rate was effectively identical to the old floating rate (90% of the 5-year treasury). Fair enough. But the Treasury Department couldn’t resist the urge to turn the screws on small savers.
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By spring 2006 the EE series was only offering 74% of the going 5-year treasury rate. By May 2010 that number had fallen to 57%. Another 4 years later, in May of 2014, it was a pitiful 30%. At the latest rate-reset in November 2017, the Series EE savings bond paid an almost non-existent 0.10%, or $10 per annum for every $10,000 invested, fixed for the life of the note. This translates into an insulting 5% of the then-current 5-year Treasury bond rate!
Savers hoping for better treatment with I-bonds were also sorely disappointed. Immediately after their introduction in the late 1990s, Series I savings bonds were very competitive, with the real rate hovering between 3.3% and 3.6%. But after the 2000 tech bubble burst, the U.S. Treasury decided it was time for the little saver to pay his “fair share”.
Real interest rates on I-bonds crashed during 2001 and 2002, declining from 3.4% at the beginning of that period to 1.6% by the end. Real rates then bounced around the 1.0% to 1.5% level until the Great Financial Crisis of 2008.
At this point, the federal government decided that I-bond holders didn’t deserve to earn any interest on their savings at all. After all, the Feds had to pay for all those bank bailouts somehow! Real rates quickly plummeted to the 0.0% to 0.2% range where they have remained ever since. That’s right. As of November 2017, Series I savings bonds currently pay a measly 0.1% as their real rate of return.
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As an added insult, the U.S. Treasury discontinued issuing Series HH bonds in 2004. These now defunct savings bonds allowed existing Series EE and I bond holders a tax-free exchange option once their notes had reached final maturity. Series HH bonds did not accrue interest like other savings bonds, but instead paid it out directly to note holders on a semi-annual basis. This way, loyal, long-time savings bond owners could defer Federal income taxes while also receiving interest payments via physical check or direct deposit.
But I believe the real death knell for U.S. savings bonds came in 2012, when the U.S. government discontinued issuing paper savings bonds. Over the decades, countless savings bonds had been gifted at holidays, graduations, weddings and birthday parties. By switching over to an electronic only distribution model, the Federal government destroyed the utility of savings bonds as gifts or savings vehicles for children. Yes, the U.S. Treasury provides optional, print-it-yourself gift certificates, but these are a laughably poor substitute for the tactile and visual enjoyment provided by an official savings bond certificate.
If you care to look at the historical record, it is pretty obvious what is going on here – financial repression. The government doesn’t want you, or anyone else, to save. Instead they want to force you to recapitalize the nation’s financial system by giving you no alternative to low-interest bank accounts. Or, if you’re inclined, the Federal Reserve is also happy for you to speculate with your life savings in the stock market casino. Either way, the U.S. government wins and you lose.
Of course, you can always refuse to play their game. That’s why I recommend you buy hard assets – things like fine art, antiques, precious metals and gemstones. Savings bonds don’t represent the safe, lucrative investments they once did. It’s time to redeem your savings bonds and convert them into tangible assets that will actually preserve your wealth.
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