More seek safety in savings bonds

US stock markets have been wobbling downward now for months. But one investment is gaining converts daily by consistently making money for its clients: US Savings Bonds.

Some personal finance gurus have called them stodgy and old-fashioned. But tell that to investors and small savers who have plowed more money into the program this fiscal year than the last. Through June, savers have kicked $8.65 billion into Series EE and Series I Bonds for fiscal year 2002, which began Oct. 1. That is almost double the $4.8 billion for the same nine-month period in fiscal year 2001.

And savers are being rewarded. The current yield of Series EE bonds is 3.96 percent. That's 90 percent of the rate of the average five-year Treasury security. But small savers may prefer savings bonds since they can be bought for as little as $25. Treasuries require a minimum investment of $1,000.

The I bond currently yields 2.57 percent. This instrument guarantees a return of 2 percent above the inflation rate, which is currently negligible. Interest earnings on both EE and I bonds are exempt from state and local income taxes. Income is also sheltered from federal taxes until the bonds are redeemed.

Why the surging interest in the US Savings Bond program? More people have grown leery of the US stock market, experts say, and are seeking safety and a consistent return, no matter how small.

"We had a string of double- digit [stock market] gains in the late 1990s, and now there is a possibility that we may have a third year of negative returns. That's a main reason why many people are taking money out of the stock market and putting it into savings bonds," says Daniel Pederson, author of "US Savings Bonds."

"Look at the alternatives," adds Mr. Pederson. "Money-market accounts are running around 1 percent to 1.5 percent; bank CDs are in the 2 percent to 4 percent range. Yet, an EE bond earns just under 4 percent."

Savings bonds have been around in one form or another during much of the last century. Series EE bonds were introduced in 1980. The I bond program started in 1998.

Currently, I bonds are outselling EE bonds. But all told, some $125 billion worth of EE bonds are outstanding, compared with some $11.7 billion of I bonds.

Savings bonds can be purchased at your local bank, through an employer via a payroll savings plan, or from the US Treasury. Direct purchases can be made by mail or online (www.publicdebt.treas.gov). The Treasury will mail you the bond, usually in a short period of time.

Later this year, the Treasury plans to let savers open accounts on the Web for I bond purchases. So instead of physically receiving a bond through the mail, you would have an online bookkeeping account. As a result, paperwork would be greatly simplified for the bond holder, says Peter Hollenback, a spokesman for the savings-bond program.

The main drawback with Savings Bonds: There are countless rules and regulations. For example, interest rates change twice a year, in May and November. That means different bonds will have different earnings over time depending on when they were initially bought.

Another point to consider: Once bonds reach maturity, they stop earning interest. About 2 million people own expired savings bonds, worth an estimated $9 billion, according to Bankrate.com.

EE bonds mature, that is, reach face value, in 17 years. I bonds have no maturity date, since they are sold at face value. Both bonds can continue to earn interest for up to 30 years, but holders forfeit three months of interest if they are redeemed within the first five years.

Once EE bonds reach mature, they can be exchanged for HH bonds. (I bonds cannot be exchanged this way.) EE bond holders have one year to make the exchange.

HH bonds earn interest for 10 years and can be renewed for another 10-year period. HH bonds currently yield 4 percent.

Pederson currently prefers EE bonds over I bonds. "People say, 'Well, if I cash in my EE bonds and don't hold them for the required five years, I'll lose three months interest.' But think about it: If you hold the bond for a year, and earn around 4 percent, and then cash in the bond, losing three months interest, you still come out with around 3 percent. In the process you've beaten most money-market accounts."

Pederson adds that EE bonds have averaged about 2.6 percent above inflation over the past 12 years, beating the 2 percent hedge of I bonds. (I bonds had a 3 percent hedge until it was reduced in May.)