My Personal Finance Blog

The inflation based (variable) component of I Bond interest rates won’t be known for sure until April 19th. (Consumer Price Index Home Page) Because inflation was abnormally high in September last year due mainly to high energy prices (Katrina), the variable component (which will go into effect May 1 based on September - March changes in CPI-U) will likely not be more than 1%. In fact, as of February, it was slightly negative!  Prices have been rising somewhat though so I expect the change in CPI-U to come in around .25% for the period which would translate into a .5% variable component.  I Bonds purchase between November and April would be earning a rate of 1.5% for their second six month period.  Far from outstanding but still not bad considering the 6.73% they are earning now.

As I mentioned before, I’ve been buying I Bonds every month since last October. I plan to continue this through this month. If the fixed rate does not rise significantly in May (2% would be great) I will likely suspend my ladder and instead begin investing in municipal bonds. Muni’s have a distinct advantage in that the earnings are federal tax exempt which can make a huge difference in returns. Also, if you purchase them from your home state they are state tax exempt as well. If I do decide to go this route I will likely buy a municipal bond fund which will not be state tax exempt but will spread my risk across many more bonds than I could purchase individually. The fund I am currently looking at is the Vanguard Long Term Tax Exempt fund (symbol: VWXLT).  It’s yield is currently 4.18% which equates to a taxable equivalent yield of 5.81% for me.   Since this is a long-term investment I am not too concerned with preservation of capital in the short run.  The fund’s price will likely drop if interest rates continue to rise.  I’ll be averaging in (monthly purchases) which further mitigates that risk plus, once interest rates begin to drop again, the fund’s price will likely rise.

One upside to abnormally low interest rates for I Bonds is that should you wish to sell them before they are five years old (say to trade into a new bond with a higher fixed component) the 3 months interest penalty will be less of an issue.  If the fixed rates do rise significantly, I’ll likely be trading in my current I Bonds for new ones as they are eligible to be cashed in.   I may also trade them into more municipal bond funds if that option continues to be favorable.