Here are my thoughts:

(from a previous post)

viewtopic.php?f=10&t=84168I'm not really a fan of EE Savings Bonds I'm afraid, at least not in their current fixed rate form. I have some of the older ones that pay a variable rate. Those I think could be a nice hedge against higher interest rates- i.e. if interest rates rise my other bond investments will take a hit but those variable rate EE bonds will start to shine...

Let's go over some of the features of EE bonds and how they might compare to an FDIC insured savings account.

1) 1.1% fixed rate

2) tax deferred

3) can't cash in for one year, for first 5 years can cash in and lose 3 months interest, after that can cash in without penalty

4) double in value if held for 20 years which works out to a 3.5% rate of interest

Let's take these features in turn

1) similar rates are available form online savings account. See this list for instance

http://www.depositaccounts.com/savings/ and of course these rates may go up in the future whereas with EE bonds you are stuck with that same 1.1% rate forever (unless you cash in early- more on that below).

2) with a rate that low the tax deferral isn't worth very much. Let's look at a holding period of 10 years. If you start with 10,000 and compound tax deferred at 1.1% and then cash after 10 years then you will have $10,867 assuming a 25% tax bracket. That works out to an after tax annual rate of return of 0.835%. If instead you have a taxable savings account with the same 1.1% rate then you will compound at a lower rate of 0.825% and end up with $10,856- basically the same, just $11 dollars less or a dollar per year!

3) to me the one year freeze and early withdrawal penalties are more important. FDIC savings accounts don't have any of these issues. Why encumber your savings with restrictions and penalties for an extra $1 per year on $10,000 of savings.

4) Now we get to the real point of your question- the doubling after 20 years. The problem is that's a long time to tie up your money. Who knows what might happen in that 20 year period. Let me paint for you the sort of scenario I worry about with this sort of thing:

a) you buy a EE savings bond yielding 1.1% but plan to hold for 20 years to get the 3.5%

b) a couple of years down the road the economy recovers, savings accounts start paying 2-3%

c) you're tempted to cash in your EE savings bonds and switch to a savings account. But you're still lured by the promise of that 3.5% after 20 years. So you don't.

d) then 10 years later rate really take off. savings accounts are now paying 6% or so. You're really tempted to cash in the EE bonds to grab that 6% rate. But then someone points out to you that if you cash in now (after earning 1.1% for 10 years) then you will need to get 6% for the next 10 years to average out to the 3.5% rate from holding the EE bonds for the 20 year doubling period. So you do nothing.

e) 5 years later rates really take off again. There is high inflation, a repeat of the 70s and savings accounts are yielding 10%. You can see where I'm heading with this now right? THe same guy points out to you that if you cash in those EE bonds now, after earning 1.1% for 15 years, then you will need savings accounts rates to stay at 10% for the next 5 years to average out to that 3.5% rate holding the EE bonds for the 20 year doubling period. So you do nothing.

f) then a few years later something bad happens. You die and your husband cashes in the bonds early. Or you get sick or laid off and need the money so you cash in early. The 3.5% goes up in smoke. And you missed out on all those higher savings rates, the 2-3% rates, the 6% rates and the 10% rates.

All this is a long winded way of saying that optionality is really important. You want products that have good optionality, like mortgages you can pay off early, or CDs you can cash in early with cheap penalties so you can invest at higher rates if you want to. You don't want the "bad optionality" that comes from having to hold EE bonds for 20 years to get that 3.5% rate,

hope that wasn't too longwinded

cheers,

grok, CFA
| "You can only convince people who think they can benefit from being convinced."- Taleb