If you haven't invested in I Savings Bonds before now, this is the time.

At the May 1 interest rate setting, new I Savings Bonds were set to yield 1.20 percent plus the rate of inflation. That rate, calculated from September 2004 to March 2005, was 3.58 percent, bringing the annualized yield to a 4.80 percent rate over the next 6-month period, according to the Bureau of the Public Debt. After that, the yield will be reset every six months based on the fixed real return of 1.2 percent plus the new trailing inflation rate.

To put that 4.80 percent yield in perspective, Bloomberg.com tells us the yield on 30-year Treasurys is only 4.51 percent. It's 4.19 percent on 10-year Treasurys and 3.88 percent on 5-year Treasurys. While we can hold I Savings Bonds for as long as 30 years with interest tax deferred, we can't redeem them before 5 years without a penalty of 3 months' interest. The long-term yield may be uncertain but these securities currently offer more yield with less risk.

What about fixed income mutual funds?

Non-starters. A recent examination of the average 30 day SEC yield on government funds in the Morningstar database showed that long, intermediate, and short term funds were yielding 3.70, 3.23, and 2.99 percent, respectively. In addition to being painfully short on actual yield, each category carried significant interest rate risk. As I've said many times, fixed income investors get little income and no respect.

Things don't get much better if you move to corporate bond funds. The Morningstar database tells us that the average intermediate term corporate bond fund has a 30-day SEC yield of 3.43 percent. That's only 20 basis points better than the average intermediate government bond fund. It's 1.37 percentage points less than I Savings Bonds.

Junk bond funds are one of the few investments that provide a higher yield than I Savings Bonds--- they provide an average yield of 5.79 percent. But to earn that additional one percentage point you have to accept high interest rate risk, credit risk, and liquidity risk.

If interest rates rise, the market value of bonds in mutual fund portfolios will decline. If you buy an I Savings Bond, the worst that can happen is that you can take a penalty of 3 months' interest if you redeem the bond before 5 years. After 5 years you can redeem it with no penalty.

History makes these bonds look good as well. According to Ibbotson Associates, the Chicago consulting firm that tracks historical asset returns, Treasury bills provided a real, after-inflation return of 0.7 percent a year from 1926 through 2004. The current return on I Savings Bonds is 1.2 percent and it's certain. Intermediate government bonds provided a real return of about 2.4 percent through the same period, but whether you actually got the real return depended on when you were investing.

T-bills, for instance, provided a real return of 2.5 percent through the 1930's--- largely because of deflation and the Great Depression. Indeed, in 1938, 1939, and 1940 T-bills provided no yield at all.

T-bills provided a real return of 3.8 percent in the 80's as then Fed Chairman Paul Volcker worked to end inflation. They brought a real return of 2.0 percent through the 90's for the same reason.

But if you had invested in Treasury bills in the 1940's, the 1950's, the 1960's, or the 1970's, your real return would have been negative in each decade. Real returns on intermediate term government bonds were negative in 25 of the same 40 years.

If you believe we are heading for a major depression and deflation, I Savings Bonds aren't a good buy. But if you believe we are heading for renewed (or just continued) inflation I Savings Bonds are the best game in town.

History tells us the odds favor inflation.

I Savings Bond vs. Other Fixed Income Investments
Compares recent yields and risk factors of majorfixed income investments.
Investment Recent Yield Maturity Interest rate risk Credit risk Liquidity risk
I Savings Bond 4.80% Na Nominal None 3 mos. penalty
5 Yr Treasury 3.88 5 yrs Moderate None None
Avg. Long Govt. Fund 3.70 15.6 yrs High None None
EE Bonds 3.50 Na Moderate None 3 mos. penalty
Avg. Int. Corporate Fund 3.43 7.1 yrs High Moderate Moderate
Avg. Int. Govt. Fund 3.23 6.9 yrs Moderate None None
Avg. Short Govt. Fund 2.99 3.6 yrs Low None None
Avg. Junk Bond Fund 5.79 6.7 yrs High High High
Sources: Bloomberg, Morningstar, Treasury

How do you invest in I Savings Bonds? Easy. Visit http://www.savingsbonds.gov/ and click on "Learn about the various ways to purchase Treasury Direct."


Economic Indicators w trailing CPI data

April CPI