The Role of Savings Bonds in Your Portfolio
What role should savings bonds play in your overall investment portfolio? How do you know the total level of savings bonds you should keep on hand? Do savings bonds offer an attractive rate of return? These common questions are just some of the things new investors should consider when deciding whether or not to add savings bonds to their collection of investments. In the next few moments, I'm going to explain some of the important considerations for those of you who are contemplating the addition of savings bonds to your family's assets.
Like the tens of millions of investors before you, you may just find savings bonds to be the perfect solution to some of your needs, especially if you are looking for capital preservation.
Savings Bonds - Bridging the Gap Between Saving and Investing
In Saving vs. Investing, you learned that saving and investing are two very different processes. Both have their own goals, risks, and objectives. Saving, for instance, represents money that is designed to be there when you need it, possibly in short order due to an emergency, job loss, or health crisis. With savings, you cannot afford to take risk because your only goal should be to maintain your purchasing power after accounting for inflation. Investing, on the other hand, represents money that you have set aside for the specific purpose of generating more money. Investing takes time, and the value of your holdings will fluctuate. That's why you need to have adequate savings on hand so you're never forced to sell out of your investments, especially in a bear market.Savings bonds are unique because they don't fit squarely in either category.
In fact, savings bonds are one of the only investments that act as a bridge between saving and investing. By guaranteeing that the investor can never lose money, as is the case with Series I savings bonds, and the right to always cash your bond in for the value of your investment plus the interest you've earned over time, means that savings bonds are de facto as safe as FDIC insured savings accounts. This is true whether you owned one of the very first savings bonds or you hold the more popular Series EE savings bonds.
Based on the risk profile of savings bonds, the closest comparison is a bank issued, FDIC insured certificate of deposit. Series EE savings bonds, which offer a fixed rate of return, are the most like CDs. Series I savings bonds, which combine a fixed rate of return with an inflation adjustment so you never lose purchasing power, is a bit more unique. You have the ability to cash the bonds in early, paying a three month penalty, much like a certificate of deposit, and your money is backed by the taxing power of the United States Government.
Advantages of Savings Bonds
Savings bonds offer several advantages, including:- No fees, commissions, or sales loads to invest
- Savings bonds are fully guaranteed by the government
- Savings bonds will not decline - you cannot lose money
- Savings bonds are not callable. If interest rates drop, you still keep your high, fixed rate.
- Savings bonds aren't subject to state or local taxes on any interest income earned.
- You may not have to pay taxes on interest income for qualified higher education expenses.
- Minimum purchase of $12.50 vs. $1,000 for Treasury bonds.
For Which Types of Financial Goals Should I Use Savings Bonds?
Savings bonds are most appropriate when:- You need to protect your capital from any and all losses. Savings bonds cannot lose money. In the case of Series I savings bonds, you will receive an inflation adjustment, as well, helping you maintain your purchasing power.
- You won't need the money for at least a year. In the case of some savings bonds, you can't access them for the first twelve months. If you cash the savings bonds before the five year anniversary, you will pay a three month interest penalty. The interest penalty isn't a big deal when factoring in the protection offered by the bonds, but you wouldn't want to put all of your savings into bonds and then lose your job three months later. In that case, you'd have to wait nine months before you hit the twelve month anniversary and could start selling off your holdings.
- You live in a high income tax state or locale. Savings bonds are exempt from all but Federal taxation, leaving more money in your pocket. If you opt for accrual tax treatment, you won't pay money on the interest that is added to your bonds each year. Instead, you will only pay taxes when you cash the bonds in ("redeem" the savings bonds).
- You want to save for your own, or a family member's, education. The interest earned on savings bonds can be exempted from taxation if used to pay qualified higher education expenses. If you are in a middle to high income tax bracket, this can be especially useful if you still qualify for the tax break. Although it may not be the most exciting gift at the time, those old US savings bonds can be a goldmine when it's time to pay the tuition bill.
Imagine you and your spouse want to save $150,000 for a down payment on four-unit townhouse apartment building that costs $500,000. You don't want to take risks with your down payment money (for more information on that topic, you can read Best Places to Invest Down Payment Money. By registering purchase under each of your names and social security numbers, you can effectively invest $5,000 each in paper I bonds, $5,000 each in electronic I bonds, $5,000 each in Series EE paper bonds, and $5,000 each in electronic EE bonds. That works out to a total of $20,000 each, per year, put safely into savings bonds. Within six or seven years, you should have your entire down payment, and you'd have never lost a moment's sleep worrying about the safety of your money.