I Bond Investments

I bonds are built to buttress inflation. Issued in eight different denominations, from $50 up to $10,000, the I Series bonds offer a fixed rate of return plus an adjustment for rising prices. Every May 1 and November 1, the Treasury announces both the fixed rate for all new I bonds and the inflation-adjustment for all new and existing I bonds. At the time of this writing, the fixed rate is 1.4 percent, and the inflation adjustment is a twice annual 1.55 percent. Adding them together, the I bonds are currently yielding 4.52 percent a year. (Yeah, 1.55 + 1.55 + 1.4 = 4.50 percent, but the added .02 percent is due to interest on interest.)

After you buy an I bond, the fixed rate is yours for the life of the bond. The inflation rate adjusts every six months. You collect all your interest only after cashing in the bond. (That is called accrual interest.)

You have to hold I bonds for at least a year, and if you sell within five years, you pay a penalty. There's a limit to how many I bonds you can invest in — $30,000 a year, per person. And in certain circumstances, the proceeds may become tax-free if used for education expenses.

Because the rate of inflation can vary dramatically from six-month period to six-month period, there are times when I bonds make for fabulous short-term investments. In November 2005, for example, after a spike in the price of oil after Hurricane Katrina, the official inflation rate shot up, and I bonds were paying a very impressive 6.73 percent. At that point, anyone who had cash to invest might have wanted to consider them very seriously. But by the following May, after inflation had cooled, the yield on I bonds dropped rather precipitously to 2.43 percent. They were no longer such a hot investment — you could have done much better with a bank CD.

If you plan to hold I bonds as a long-term investment (longer than a year or two), you should be more concerned with the fixed rate, which will be in effect throughout the life of the bond, than the inflation adjustment, which will vary. Remember that if you cash out before five years, you'll pay a penalty of three months' interest. You can purchase I bonds at your bank or by visiting TreasuryDirect.

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Source:http://www.dummies.com/how-to/content/i-bond-investments.html