The I bond, the government's inflation-fighting savings bond, could see its highest composite rate in three years when the new rate is announced Nov. 3.
Based on the latest six months of inflation data, Dan Pederson, author of "Savings Bonds: When to Hold, When to Fold, and Everything In-Between," says he expects the new rate to be about 5 percent -- a slight increase from the current 4.84 percent.
The I-bond's rate is comprised of two components -- a fixed rate that sticks with the bond for its 30-year life, and an earnings rate that's adjusted semiannually based on inflation.
The new annualized I-bond rates are announced every May 1 and Nov. 1.
The current I bond has an adjustable rate of 4.84 percent and a fixed rate of zero. Last May, for the first time in the bond's 10-year history, the Treasury Department gave the fixed rate a goose egg. Thanks to several months of considerable inflation in this most recent six-month period, Pederson says the predicted adjustable rate is so attractive that Treasury might once again leave the fixed rate at zero.
"In my opinion, the value is in buying before Nov. 3. Lock in the current 4.84 percent for the first six months and then for the second six months you'll get whatever is published this Nov. 3," says Pederson.
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I-bond rules require you to hold the I bond for 12 months before cashing. If you cash out in fewer than five years, you must pay a penalty of the latest three months' interest.
Annualized rate of 4.92
If you follow Pederson's advice and buy the current bond, you'll get 4.84 percent (annualized) for six months. Assuming Pederson is correct and the Nov. 3 rate is 5 percent, you'd receive that rate for the second six months. For the 12-month period, your annualized rate would be 4.92 percent. Subtracting the 1.23 percent penalty leaves you with a yield of 3.69 percent.
"If people are comparing that to money market funds, they'll see that 3.69 percent, subject to federal tax but exempt from state and local tax, is very competitive," Pederson says.
The reason you'd probably want to sell the bond after one year is because the government will likely begin issuing bonds with a fixed rate in the near future, and those instruments would be considerably more valuable over time than the current bond, even if they have a lower adjustable rate.
Series EE bonds, which only have a fixed rate, will also be adjusted Nov. 3, but the current rate of 1.4 percent shouldn't change much, says Pederson.
It's believed that the government is phasing out the EE and is making it less and less attractive by sticking it with very low interest rates.
On another note, Pederson says some of his clients who have a lot of bonds maturing over the next five years are cashing some of them before the end of the year.
"The belief is that no matter who gets in the Oval Office, tax rates probably won't drop, despite what they say in the debates. What I'm hearing is that, because of the accrued interest aspect of savings bonds, they'd rather take some money off the table now at their current tax rate rather than wait a couple years and risk whatever that tax rate will be."
For additional information on the I bond, visit Bankrate's Investing Basics.