If your investment strategy includes long-term bonds, you may want to consider U.S. savings bonds (typically referred to as Series EE Bonds). In addition to being patriotic, savings bonds just might represent a smart investment in an ever-fluctuating economic environment. To make an informed decision, you need to compare savings bonds with other types of long-term bonds available to individual investors.
Types of Long-Term Bonds Available
There are three main types of bonds: Treasury bonds (T-Bonds) and savings bonds (which are issued by the federal government) municipal bonds (issued by cities, regions or states) and corporate bonds (issued by public or private companies). Long-term bonds refer to securities that take 12 years or more to mature to full value.
Savings Bond Risk
When it comes to risk, it's hard to beat U.S. government–issued bonds. Both Treasury bonds and savings bonds are backed by the full faith and credit of the United States government. Municipal bonds come next in line, as state and local governments rarely go bankrupt (although Detroit's bankruptcy in 2013 might give some investors pause).
Municipal bonds are available at three bond-rating levels: AAA, AA or A, with AAA being the least risky and A being the riskiest. Corporate bonds are the riskiest of all bond types, because they are issued by a company, not a government. These bonds are also rated AAA, AA or A, just like municipal bonds.
Yield is the interest rate paid by the bond. In October 2018, composite bond-yield rates for 20-year corporate A-rated bonds hovered near 3.88%, municipal A-rated 20-year bonds came in at 3.62% and 20-year Treasury bonds yielded 3.18%.
This is where savings bonds shine. Thanks to a little-known government guarantee, Series EE savings bonds held for 20 years are worth twice the amount paid for them. That's a yield of 3.53%, which usually beats everything but the riskiest corporate bonds. For any period less than 20 years, savings bonds pay only the base rate (currently 0.1%), which they continue to pay for up to 30 years.
When it comes to liquidity, savings bonds stumble compared to other options. It is important to remember that you only get that government guarantee of doubling your money if you hold the savings bond for a full 20 years. In addition, you can't redeem a savings bond during the first year you own and, if you redeem it within the first five years, you will lose the last three months' interest. Finally, savings bonds can't be traded or sold between individuals (no secondary market) and must be redeemed through the government itself. By comparison, Treasury bonds, municipal bonds and corporate bonds are much more liquid; all three types can be traded on a secondary market before maturity. The rules for each vary as a group, but all are substantially easier to liquidate versus savings bonds.
Series EE savings bonds have no inflation protection. A second type of savings bond called the Series I bond earns the fixed-interest base rate plus an inflation rate, which is calculated twice a year. It is not, however, eligible for the 20-year "doubling" guarantee. Although regular Treasury bonds have no inflation protection, Treasury Inflation Protected Securities (TIPS) do. TIPS pay a lower interest rate than regular Treasury bonds, so when you buy them you risk the possibility that inflation will not rise more than the difference in yield between regular Treasury and TIPS. Regular corporate bonds do not have inflation protection, but inflation-linked corporate bonds such as TIPS do.
Savings bonds come in denominations ranging from $25 to $10,000. You can only invest a maximum of $10,000 per year (per taxpayer) in savings bonds, making them the most constrained of bond investments. Treasury bonds are available starting at $100. There are two processes (besides the secondary market) for buying them: noncompetitive bids and competitive bids. Noncompetitive bids are limited to $5 million. Competitive bids by an individual cannot exceed 35 percent of the total offering. Municipal bonds typically come in a minimum denomination of $5,000, and there is no maximum amount you can invest, as long as bonds are available. Corporate bonds typically require a minimum investment of $1,000, with no maximum investment limit.
Savings bonds are subject to federal income taxes but not state and local. If your Series EE savings bonds are used to pay higher education costs, you can do so tax-free, provided you earn no more than the limits. No matter what, you have the option to delay paying federal taxes on Series EE bonds until maturity at 20 years. Municipal bonds are not subject to federal taxes, and in some cases state and local taxes are also excluded. Generally speaking, interest on corporate bonds is taxable.