The Benefits and Risks of US Savings Bonds

You might remember US savings bonds as that infamous graduation gift, a pledge of money in support of a war, or perhaps an investment towards that decade-old scholarship that still loved the idea of making money while helping out the greater good of the nation. Today, US savings bonds have fallen by the wayside as the demographic that fueled the US savings bond fire is dying off. Savings bonds are still the world's safest investment, but require some fundamental understanding to get the most out of a US savings bond.

Savings Bonds are Competitive for Safe Investments

US savings bonds pay returns that are about equal to the average certificate of deposit.  Alhough you won't get the returns of the NASDAQ, you're not accepting the same level of risk. Savings bonds also have huge tax advantages -- which allow you to cash in the savings bond at a deferred time. Cashing in later, say in your retirement days of lesser income, will drop your overall tax bill. Plus, US savings bonds are completely exempt from your state and local taxes. This could be the difference between a decent return and a solid yield; tax exempt status on the local level makes savings bonds prevail over CDs and money market funds, but there are some rules that have to be properly monitored.

US Savings Bonds Pay Semiannually

US savings bonds collect interest twice per year, dampening the compounding and punishing investors who go for a short term sale. If you sell your savings bonds 3 months before the next interest payment, you won't receive any payment for that 3 months the government held your money. Instead, you'll receive however much had accrued at the last time of the interest payment. Savings bonds cannot be cashed in within the same year, and cashing in within 5 years will result in a penalty payment. These are no short term vehicle for investment; US savings bond investments have to be properly thought out. Unlike money market funds with a daily interest calculation, US savings bonds are locked up. If you think you'll need the investment capital within 6 months, or at a time that cannot be determined at the time of investment, a money market fund would better suited. For the long term though, US savings bonds still make a great investment vehicle.

Inflation Risk

In times of high inflation, US savings bonds are some of the worst investments. There is a way to cope with this; the Series I savings bonds have a generic interest rate that is then added on top of government calculated inflation for the year. When inflation is higher, you'll get a better return to cope with higher inflation. In times of low inflation, you'll earn less, but your dollar will go further. Inflation adjusted bonds have grown in popularity as investors want to beat inflation to grow the spending power of their holdings over time. Merely reaching the point of inflation only sustains your spending power; growing your money can only be done by beating inflation and achieving an additional return. For this purpose, US savings bonds are a great way to do it.