It turns out you may want to buy more of those colorful pieces of paper your grandma used to give you.
At first glance, it appears EE series savings bonds offer a paltry interest rate rivaled by today’s checking accounts, but they have one special feature, which has been irrelevant until 2009, when interest rates plummeted. Because of this little known feature, these pieces of paper could be your highest yielding bond investment today.
Actually, Today EE series savings bonds can only be purchased electronically (Sadly, there are no more new paper savings bonds like your grandma used to give you). They can only be purchased electronically on TreasuryDirect.
When you purchase an EE savings bond today you are purchasing a bond with a fixed rate for 20 years, after which the rate can be adjusted for the final 10 years of the bond’s maturity. Today that rate is 0.5%, as seen on TreasuryDirect:
(You can find the current EE savings bonds rate here: http://www.treasurydirect.gov/indiv/research/indepth/ebonds/res_e_bonds.htm)
This rate for new bonds is subject to change May and November of each year.
I won’t go into much detail on the ins and outs of EE series savings bonds, because we have in this article here: What Do You Know About Savings Bonds?
Wait, so why am I on here talking highly of an investment with a fixed rate of 0.5%? Well, the reason is because EE savings bonds have one additional feature that historically has not been that important or applicable, but in today’s low interest rate world makes it one of the better long term bond investments out there.
EE Series Savings Bonds
The added feature of EE series savings bonds is found within Treasury Direct’s explanation of the bond: http://www.treasurydirect.gov/indiv/research/indepth/ebonds/res_e_bonds_eeratesandterms_eebondsissued052005andafer.htm
Remember the first image above showing a 0.5% fixed rate? Well it turns out this doubling guarantee gives EE series savings bonds a return of much greater than 0.5% ONLY IF HELD FOR 20 YEARS or more. If you sell the bond after 19 years, you will earn only that 0.5% each year.
Just what kind of return do EE bonds get if held for 20 years?
An investment that doubles in 20 years is equivalent to receiving about 3.52% annually…quite a bit better than 0.5%! And actually, quite a bit better than a 30 year treasury bond which as a write this is at 3.31%!
(How did we calculate that? See our post here: How Long Will It Take To Double Your Money? – Heres How To Calculate It )
So maybe your grandma was right all along to give you those savings bonds.
But wait, there’s more.
EE Savings Bonds Get Even Better
EE series savings bonds may also earn interest tax free if being used for “qualified education expenses”, of which the government gives a detailed explanation for what qualifies here: https://www.treasurydirect.gov/indiv/planning/plan_education.htm
So, if you are buying EE series savings bonds for use 20+ years from now for an education expense, your “real” pre-tax rate of return would be 3.98%. (That is, the rate a comparable bond without the education tax benefit would have to have in order to complete with the savings bond)
And in today’s low interest rate world, you are not going to find an investment with a near 4% GUARANTEED return anywhere else.
The Cons of EE Series Savings Bonds
This “excellent” 3.52% return does come with some caveats however.
In order to get the guarantee of the savings bond doubling, you must hold the bond for 20 years. So, if you think you will need to sell the bond prior to the 20 year maturity being reached, look at some traditional treasury bonds instead.
To get an idea of how returns of an EE savings bond compare to those of a 30 year treasury bond:
It is pretty obvious the benefit of owning the bond for greater than 20 years!
However, note that this graph assumes a lot after year 20. First, an EE series savings bond’s rate will likely change after year 20, this graph above assumes a constant 0.5% all 30 years.
This also assumes equal tax treatment, which is not the case for all. If you are lucky enough to be able to use these bonds for a qualified education expense, your returns on EE bonds look even better (assuming 15% long term capital gains tax):
Better, but once again shows the importance of being able to hold onto the bond for 20 years.
Conclusion
For those who are certain they can hold an investment for 20 years, EE savings bonds are a compelling option, certainly if they can be planned on being used for qualified education expenses in the future. However, you will get burned if you sell the savings bonds a day before 20 years is reached.
Also, EE savings bonds have some limits ($10,000 per year), that treasury bonds do not have. So if you are looking for a place to park tens of thousands of dollars today, this may not be the best option for you. But for those who are starting to save early, with small amounts at a time, these EE savings bonds may turn out to be a great bond investment.
