US Savings Bonds lose a bit of interest, but they keep fundamental appeal

The way people lined up to buy United States Savings Bonds last week, you'd have thought the government had killed them off completely. All the Treasury Department did, of course, was lower the minimum interest rate from 7.5 to 6 percent. But that was enough to keep bank tellers and clerks very busy late in the week selling thousands of savings bonds to small savers, investors, and people who just wanted one of the last of the higher-interest bonds.

Now, if you want a savings bond, you'll have to be satisfied with a minimum interest rate that is 20 percent less.

But that's not bad.

At 7.5 percent, savings bonds were an exceptionally good deal - too good, actually, considering the current interest rate environment, where the national average on one-year certificates of deposit is about 6.2 percent and five-year CDs pay 8.3 percent. With both certificates, however, you have to deposit at least $500 to $1,000. Savings bonds start at $25 for a $50 issue.

There aren't many places where you can get a 6 percent yield, a US government guarantee, and freedom from state taxes - all for $25. Savings bonds also have a tax deferral feature: Federal taxes don't have to be paid until the the bonds are redeemed, and that tax can be deferred further if the Series EE bonds are converted into Series HH bonds at maturity.

Yes, you have to keep the bonds for at least five years to get 6 percent, but savings bonds were always meant to be savings vehicles anyway, and five years is still less time than you might have to keep money tied up in an individual retirement account.

``Given all the conditions of a low-interest-rate environment, 6 percent is not a bad deal,'' says Robert Heady, publisher of 100 Highest Yields, a North Palm Beach, Fla., newsletter. ``Consumers should not compare this to the 8, 9, 10, or 11 percent numbers we had before, but to the lower numbers we have now.''

Mr. Heady finds some connection in the fact that the cut in the savings bond rate and the reduction in the discount rate in Japan from 3 to 3 percent both occurred on the same day, last Friday.

``We have set the stage for a long period of lower interest rates worldwide,'' he says. In this environment, savers should not expect their government to pay substantially more than the marketplace.

While the Treasury did lower the minimum rate, it did not change the floating-rate feature that could result in a higher return after five years. ``The rate will continue to float and be adjusted each March 1 and Nov. 1, based on the market rate of five-year Treasury bonds,'' says Steve Meyerhardt, a spokesman for the Treasury.

So when you redeem the bond, the yield you actually get will be based on a combination of all the rates that were in effect during the five years, but will be no less than 6 percent. The rate for the next six months, for example, is 6.06 percent.

While you have to hold the bond at least five years to get the minimum rate, last week's change does stretch out the time it takes for a bond to mature - that is, to double or reach its full face value. It will now take 12 instead of 10 years.

While many economists felt 7.5 percent was too much for a deficit-laden government to pay small savers, others believed the higher rate encouraged Americans to save more. One measure of how savings habits might change because of the lower rate should turn up in the purchase of bonds through payroll-deduction plans. With 401(k) and 403(b) retirement savings plans now in place at many US companies and institutions, workers may find savings bonds less competitive.

Also, since savings bonds began paying a floating interest rate four years ago, rate-conscious savers have begun putting their money in other places, which have varying degrees of safety and tax deferral.

High-grade municipal bonds, for example, are paying yields in the 6.5 to 7 percent range. Income from these bonds is free of federal taxes, and, if you buy bonds issued by the state where you live, from state taxes, too. But the minimum investment is about $5,000, and you'll have to pay a broker's commission.

You can also get tax deferral in muni bonds through a mutual fund. The minimum investment is smaller, usually $500 to $1,000. Yields are about 6 percent, but there is some risk of lost capital through a declining share price, or net asset value.

High-rated corporate bonds are paying 8 to 9 percent, but here again there is some risk and the minimum investment is usually $5,000. Also, the companies issuing these bonds may pay them off before maturity, ending an income stream you expected to last longer.

Five-year Treasury notes are paying about 6.8 percent, and they can be bought for as little as $1,000.

Most small savers, however, who are putting away $25, $50, or $100 at a time, really have only one risk-free alternative to savings bonds: federally insured banks and savings-and-loans. Some banks will beat 6 percent with a six-month CD, but at most banks, you'll have to stay for a year and put in at least $500.

Considering the alternatives, then, while the new rate on savings bonds is lower, it's not bad, especially for a risk-free way to build a nest egg.

If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway St., Boston, MA 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.