Howls of protest started the moment the Treasury did its twice-annual reset of the interest rate on I Savings Bonds. It dropped the rate from 6.73 percent annually for the November-April period to a mere 2.41 percent for the May-October period. The basis for the new rate was a 1.40 percent annual return that would be fixed for the life of the bond plus a 1.00 percent annualized inflation rate for the May-October earnings period. In each future period the rate would be the combination of 1.40 percent plus the trailing inflation rate.

William J., a Waco reader who has bought I Savings Bonds since their inception in 1998 wrote, "If it is the intent of the Treasury Department to get out of the I bond business, they have certainly chosen a quick way to do it. I can't foresee anyone purchasing new I bonds, and I foresee an increase in redemption."

Most people were more like Donald T. of Wills Point Texas---mystified by the size of the change and skeptical about the incredibly low inflation rate used for the period.

In fact, I believe I Savings Bonds are a better buy today, at 2.41 percent, than they were when they were 6.73 percent. A little patience and the I Bonds you buy today will bring bigger rewards tomorrow.

You can understand by considering how the yield on these bonds is set. I Savings bonds provide a yield that is based on a rate that is fixed for the life of the bond, plus the inflation rate for the preceding six months.

The inflation rate used is the CPI-U, the Consumer Price Index for all urban consumers tracked by the Bureau of Labor Statistics. The CPI-U is the overall rate of inflation, including energy and food. The CPI-U rate used for the recent reset covered the period from last September through February. When the rate is reset once again in November, it will use the CPI-U inflation rate for the period beginning March through August of this year. Simple, it is not.

Last year, when the rate was reset in November, the CPI-U inflation rate for March 2005 through August 2005 was used. That's when gasoline prices soared and the inflation rate for the six month period was 2.85 percent. Double that and you get a 5.7 percent inflation rate. Add the 1.00 percent fixed rate and you get a 6.7 percent yield. (The actual yield was slightly higher, 6.73 percent, due to a compounding adjustment.)

When the rate was reset this month, the CPI-U inflation rate for October 2005 through March 2005 was only 0.5 percent, much of it due to the temporary decline in gasoline prices. The adjustment for purchasing power over the 12 month period comes very close to the 3.4 percent rate reported by the Bureau of Labor Statistics--- (1.0285x1.005=1.0336, which rounds to 1.034). So I Savings Bond holders are getting their proper inflation adjustment--- but it isn't delivered in equal portions because inflation rates vary.

The more important fact here is the fixed rate--- the "real" return over the inflation rate. The 1.40 percent for bonds sold in the next six months is the best rate offered since late 2002, when the rate was 1.60 percent. If you believe inflation will be 3 percent or more in the future, I Savings Bonds are very competitive with both conventional Treasury securities and tax deferred annuity products.

The I Savings Bond Inflation Premium
Series I Bond Issue Dates	Fixed Rate
May 2006-October 2006	1.40 percent
November 2005-April 2006	1.00
May 2005-October 2005	1.20
November 2004-April 2005	1.00
May 2004 -October 2004	1.00
November 2003-April 2004	1.10
May 2003 -October 2003	1.10
November 2002-April 2003	1.60
May 2002 -October 2002	2.00
November 2001-April 2002	2.00
May 2001-October 2001	3.00
November 2000-April 2001	3.40
May 2000 -October 2000	3.60
November 1999-April 2000	3.40
May 1999 -October 1999	3.30
November 1998-April 1999	3.30
September 1998-October 1998	3.40
Source: http://www.publicdebt.treas.gov/sav/sbirate2.htm

Here's why. I Savings Bonds can be purchased in amounts as small as $50 and can be redeemed anytime after 12 months. The maximum penalty for redemption before 5 years is the last three months of interest. While you hold the bonds, the interest they earn accumulates tax-deferred until the bond is redeemed. You can hold them as long as 30 years.

Few CD-like annuities offer the flexibility of purchase, low early redemption costs, or the likely yield of I Savings Bonds. TIPS, Treasury Inflation Protected Securities, offer a higher premium over the inflation rate (2.27 percent for a 5 year note, 2.46 percent for a 20 year note) but the income is not tax deferred and their market value will fluctuate with interest rates.

Bottom line: While the yield on I Savings Bonds over the next six months will be below what investors have come to expect, they are still a good bet for investors seeking safety, flexibility, and inflation protection.

On the Web:

I Savings Bonds, individuals

I Savings Bonds, current earning rate

I Savings Bonds, history of basic rate and inflation rate

Savings Bonds earnings report, link to PDF file

Bureau of Labor Statistics home page

CPI report for March 2006 with 7 month history, annualized figure

CPI-U history, monthly index from 1913 to present

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Personal finance writer Scott Burns is syndicated by Universal Press. His twice weekly column appears in newspapers from Boston to Seattle. He is the Chief Investment Strategist for AssetBuilder, Inc. Readers can register at www.scottburns.com. Questions/comments can be posted directly. They can also be sent, without registration, to scott@scottburns.com. Questions of general interest will be answered in future columns and on this blog.

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