All Financial Wisdom

How do Savings Bonds fit into your Financial Strategy

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16215260924_9266d0ff6e_nSavings Bonds can be a useful tool in your diversified portfolio. However, they may be difficult to purchase as they are not as a common tool as they once were.

Savings Bonds are a financial instrument that allows an investor to loan money to the U.S. government through the U.S. Treasury.  The Treasury determines the particular interest rate and are offered with a 20 or 30 year term.   Interest is paid every 6 months as determined by the interest rate, which is also known as the coupon rate. Bonds are a considered a fixed-income security due to the predictable income and value of them over time.

The corporate world also has there own kind of bonds called Corporate Bonds.  They typically have higher interest rates associated with them and are more risky, since there is a greater chance of default.

Savings Bonds in History
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Savings Bonds or U.S. Savings Bonds, are bonds that are secured by the United States Treasury.  They are backed by the U.S. government, which is considered a extremely low chance of defaulting on them.  These bonds were first issued as a financial instrument when President Franklin D. Roosevelt signed legislation in 1935 and quickly become known as War Savings Bonds as the United States went into World War II.  A little piece of random trivia, President Franklin D. Roosevelt was the first person to purchase a savings bond, which was a day before they were made available to the public.

Savings Bonds Information

There are two types of Savings Bonds; EE-Bonds and I-Bonds.

  • EE-Bonds have interest rates that are fixed when purchased.  Tax is deferred until it is cashed.  They are guaranteed to double in value within 20 years.
  • I-Bonds have a fixed and variable portion of interest rates.  The fixed part is fixed when purchased, while the variable part of the interest rate changes every 6 months following consumer price inflation.  In times of deflation, the variable interest rate can be less than zero, but the combined rate cannot be.

These bonds are only purchased through the Treasury Direct website at TreasuryDirect.gov.

Savings Bonds Rules

When purchasing savings bonds, you can buy in increments of $25, $50, $75, $100, $200, $500, $1,000 and $5,000. However, a maximum of $10,000 of saving bonds can be purchased per person per year.  To keep track of this, your Treasury Direct account requires your social security number, mailing address, and bank account information.

When redeeming a bond, consider the possible penalties.  First, you cannot redeem the bond until after 1 year.  If you have held the bond at least that long but less than 5 years, three months of interest will be forfeited.  If it has been greater than 5 years, there is no penalty.  The interest earned from these bonds are federally taxed.  However, if you use the proceeds to fund college education, taxes may not be owed.

It is important to note that after the duration of the bond, the bond stops collecting interest.  At that time, cashing out is the proper remedy.

Other Treasury Financial Instruments

When on the Treasury Direct website, you might see Treasury Bills and Notes along side of the Savings Bonds we have been discussing.  These are all still backed by the U.S. government and each have their own specific purpose.

Treasury Bills (T-Bills) are short-term obligations issued for 1 year or less.  They are sold at a discount to face value.  The interest sold at a discount to face value.

Treasury Notes are short to long-term obligations issued for 2, 3, 5 or 10 year terms.  The interest is provided semi-annually like bonds.

How to Purchase Savings Bonds

I have put together two short videos to help you go through this process, with the first being how to open an account at TreasuryDirect.

 

As you can see, it is quite easy and quick to do so.  The process is very similar to purchasing Treasury Bills, Notes, and TIPS.

Savings Bonds Strategies

Savings Bonds can be a part of your overall retirement and financial plan.  They can be made of up various amounts of money, have almost no risk of defaulting, and can have better saving rates than a normal bank account or Certificate of Deposit.  When using Savings Bonds as a retirement savings device, adding a co-owner or a beneficiary is important.  The bonds can pass to your heir without going through probate.  This saves time if your spouse needs it.

When a bond is redeemed, all interest earnings are taxable at that time.  Depending on where you are in your tax bracket, it could push you up to the next one forcing you to pay more taxes that year.  Selling them strategically would be wise.  If you are cashing them out at their maturity, you would know the value and can plan for the added taxable income.

13855879173_ef08eb8836_nFor a financial plan’s asset allocation, bonds are typically one of the major parts along side stocks and international stocks and bonds.  Bonds provide a stable, safe, and predictable amount of interest for the investor.  The large swings of stocks that take years to recover from do not fair well for retirees. In response, bonds typically become a larger part of an investor’s portfolio as they age towards retirement and through life.  It is common for investors to hold their age in bonds.  Such as, a 55 year old man shall aim to hold 55% of his portfolio in bonds.  As they get older, their bond side of the portfolio grows, and their risky stocks portion shrinks.

You can get exposed to bonds through exchange traded funds and mutual funds as well.  For example, Vanguard’s Total Bond Market ETF (BND) is a ETF that tracks the performance of the Barclays Capital U.S. Aggregate Bond Index buy purchasing a variety of bonds.  These bonds include a major portion of U.S. Savings Bonds and different ratings of corporate bonds.  Most 401k’s provide a bond-focused fund that may be similar.  Investing into bonds through ETFs and Mutual funds come with expense ratios and trading commissions.  However, having the ability to invest with no cap and being able to trade whenever you want probably outweighs those small costs.

A great resource I suggest to learn more about Savings and Corporate Bonds is Investopedia’s Bond Basics Tutorial.  Please feel free to let me know how you use bonds as part of your financial strategy.

 

photo credits:

Bonds via photopin (license)

Match Book For Victory Buy United Stamps War Savings Bonds And Stamps WWII via photopin (license)

Nest Egg of Cash via photopin (license)

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