Banks Make Money on the Spread, Why Shouldn’t Savings Bond Owners?

You may have never thought of it this way, but your savings bond holdings have a spread of interest rates. Savings bond rates have ranged from a low of 0% to a high of more than 8% over the last 24 months.

Banks make money by borrowing at low rates such as .05% on our savings accounts, and lending at higher rates like 6% or more on a car loan. The difference is the spread between the cost of what they borrow and the income from what they lend. If I can borrow $10 million dollars at 1% and lend it at 6% I will make $500,000 a year in interest. All my lending, of course, would need to be without default, and that is another story, but the concept is making money on the spread.

Wise savings bond owners can do the same. Suppose you are going to cash $10,000 of savings bonds a year for the next three years while holding others. Wouldn’t it make sense to cash the worst performers and hold the best? How do you know which is which? An analysis of your savings bonds investment will determine the exact rate for each bond and how long that rate will last. While the government data is useful, it does not address some of the analytical questions necessary to maximize your overall return. A savings bond statement (see example) provides the detail needed to maximize your savings bond investment. Whether you like banks or not, this is one strategy that can be borrowed from the big guys and applied to the way you manage your savings bonds.

Small Potatoes are Better than No Potatoes

Have you noticed the interest rates banks are paying (or not) these days?  My friendly bankers are offering anywhere from .5% to .75% on CDs.  Money market funds and savings accounts are even more anemic at around .1%.  Pretty soon they will have to rename the latter the “non savings account.” If you have any money, banks want to use it for free.

This leads to the small world of savings bonds. I actually purchased the paper I Bond maximum, $5,000 per person per year, in December and will do so again in January. Here is why. The current I Bond pays 3.36% for the first six months and has to be held for one year. If cashed at the end of the year, three months interest is forfeited. Because the I Bond will receive 3.36% for the first six months, even if the rate is 0% for the second six months, the worst I can do is an annual return of 1.68%, guaranteed, tax deferred and exempt from state and local taxes. If inflation is somewhat normal (around 3%) for the second six months that my bonds are held I will net more than 2.52% after one year. This is not going to make me rich, but it feels better than loaning my bank money at a near zero percent return.

For more information about the I Bond please consult my annual newsletter. You can also read my comments in USA Today regarding purchasing I Bonds with your tax refund.