Help a Reader: Savings Bonds

Here's an email question I recently received from a reader:

I have ~$2000 (current value) in savings bonds that were purchased for me as a child. They did not get used for college, so now I'm trying to figure out what to do with them. They're all currently earning 4%. I'm considering either holding on to them or cashing them and putting them in my Roth IRA (invested in aggressive index funds). I feel like it would be a good time to change them into stocks due to the current market, but am a bit wary about losing my guaranteed 4% in exchange for high market volatility.

Other important info: I'm 25, I have other means for fully funding my Roth IRA if I don't use the bonds, and I don't need to add to my emergency fund.

What would you suggest she do?

Comments

[largebill]

If it is only a couple thousand it can't hurt to just hang on to them. You won't get rich on bonds but having a small percentage in a safe slow growth vehicle isn't that bad an idea. Plus bonds are relatively liquid. Consider it a back up to your emergency fund. When the refrigerator dies a week after the hot water heater quits she'll be glad to have a back up and not have to sell stocks at an inopportune time. I've got old bonds sitting in a safety deposit box for just this reason. Have I been tempted to cash them in when I thought I had a "great" idea? Sure. However, there is a certain amount of comfort in having that cushion.

[Chief Family Officer]

If she expects to be in a higher tax bracket when they hit full maturity (30 years) - and it seems likely that she would be - she would cash them now, pay the taxes on them, and then re-invest. If capital preservation is a concern, the money could still be invested conservatively in a tax-advantaged account. Of course, this is all assuming that there are no outstanding debts (like student loans) and that retirement savings is really the big financial goal.

[Jon]

I saw a post somewhere recently about converting paper bonds into electronic bonds. That way they don't get lost or damaged. If you decide to keep the bonds that may be something to look into!

[Big Z]

If you consider your savings bonds an "investment" I would cash them out and put them in a diversified index fund like you suggested. Inflation is on a tear this year with the Fed flooding the market with money to bump up liquidity. Further, if you count in taxes you will be under water most of the years you hold the bond. The good thing about equities is they adjust for inflation as companies pass on rising costs to consumers. Also, S&P 500 companies usually have some international operations that takes advantage of strong foreign currencies and a weak dollar which makes foreign earnings more potent for US investors. By your comments and the fact that you are younger you do not need income components in your investments just yet.

I would go with your idea of cashing out the bonds and investing them in this down market. There are a lot of very good companies selling for very cheap. Buying an index allows more tempered exposure to the equities market with little amounts of cash.

~Z

[Matt N]

If he's considering putting them in an IRA then he shouldn't be so concerned about market volatility. It will all but disappear when looked at over a 40 year timeline. The market returns over that time will vastly outpace his 4% bond, especially when put in a tax sheltered vehicle like a Roth IRA.

He says he already has a fully funded emergency fund, so I see no reason for him to keep the bond laying around earning such poor returns when there are obviously better places to put it. Another place I might suggest putting it if I were him is to paying down any debt that he has, even if it's at a relatively low interest rate. Paying down a mortgage or student loans at 5-6% will still give him better returns than that bond, and he won't be paying taxes on the returns either.

[Matt N]

If he's considering putting them in an IRA then he shouldn't be so concerned about market volatility. It will all but disappear when looked at over a 40 year timeline. The market returns over that time will vastly outpace his 4% bond, especially when put in a tax sheltered vehicle like a Roth IRA.

He says he already has a fully funded emergency fund, so I see no reason for him to keep the bond laying around earning such poor returns when there are obviously better places to put it. Another place I might suggest putting it if I were him is to paying down any debt that he has, even if it's at a relatively low interest rate. Paying down a mortgage or student loans at 5-6% will still give him better returns than that bond, and he won't be paying taxes on the returns either.

[Laura]

I was in the exact same position last summer (and the same age). I elected to cash mine out and put the money in a Roth IRA. My only regret is not cashing them out while in college. If I had known to do so, I would have saved several hundred dollars in taxes.

[MoneyIllusion]

Buy a couple of ounces of gold and silver as a hedge against inflation. Just go to a coin shop and ask to buy gold bullion. American Eagles, American Buffaloes or Canadian Maples are pretty popular. Expect to pay between 3-5% over spot prices.

[Everyday Finance]

Hey there, great topic: Given the long time horizon, lack of need for an emergency fund and the paltry yield, equities are the way to go. I recently cashed in the savings bonds that were given to my children during their first year. With a 17 year time horizong for college, it was inappopriate to be holding the most risk (and return)-averse instruments for that time horizon.

[cheapogroovo]

Stop the bonds! They don't keep up with inflation!

[Good Money Blog]

It looks like the fixed rate of the I-bonds is only around 1% (not high)?

Unless you plan to use the money in the next 5 yaers, the I-bonds are not doing anything for you. The inflation rate now is 4%, your real interest rate from the I-bonds is virtually 0%.

If I were you, I'll put that into an emerging market ETF such as VWO or EEM (inside a taxable account if IRA/401k have already been maximized).

[JACK]

My advice: you have probably wasted in terms of time more value worrying about squeezing some extra gains out of this measly 2,000 dollars than you will get if you cash them out, pay taxes on them, then invest them again. I'm sorry to be blunt, but sometimes sometimes people on this blog seem to major in minors. A few other thoughts:

#1: These bonds are very unlikely to be i-Bonds. i-Bonds didn't start until 1998, so unless by "child" she means 15, I doubt we are talking about i-Bonds. (And telling people to sell their i-Bonds just because the Treasury decided to dump on savings bonds investors and set the fixed rate to 0% is just not thinking it through. You need to know what the fixed rate of the iBonds that they own are to know what the rate will be. For example I've got some that will earn close to 8% over the next six months because I got the advantage of a high fixed rate with the new higher inflation rate.)

#2: Despite my thought that it frankly won't make much of a difference to a person like the writer who has plenty of cash flow to fund a Roth without using these bonds to do it (and I would rather see that done than the temptation some might face in thinking that they've met their annual funding goal when they didn't contribute any new funds, but just shifted money around), I would say now isn't the time to buy bonds. The government seems determined to crush the savings bond program. Rates are pathetically low at the moment. So I wouldn't put any new money into them.

[JACK]

I might cash them out though when the interest earning period ends, which if these were bonds purchased at her birth, might not be that far away.

[JC]

What the heck is an "aggressive index fund"? Small Value index? Emerging small index? What is that, by the way?

Also, if you're uneasy about giving up your 4% to invest in "risky" "high volatility" stocks, then you're not ready for the stock market. Period.

Also, the idea to dump it all into emerging markets is silly (VWO/EEM). What kind of asset allocation is THAT? 100% emerging markets? Nuts.

Put it in a target retirement fund with Vanguard. When you've got 50k or so, then you might be ready to customize your allocation. Until then, you're just entertaining yourself.

JC

[Ryan S]

I never understood relatives buying savings bonds for a child. A child is an investing candidate with the longest time horizon of any of us, so they should have bought you stock certificates. You are 25 now, and let's assume you were given these bonds 20 years ago at around $1000, you'd now have around $5000 instead of $2000 if it was invested in a simple stock index fund. 25 is still young and don't delay now to put them in stocks, because by 65 you are talking around $10,000 if you keep this in bonds, and $65,000 if you put this in stocks. Disclaimer: Past returns do not guarantee future returns.

[LC]

@JC - I don't think the reader was expressing apprehension at the "volatility" of the stock market in general. I think she was just stating (correctly) that even outside of an emergency fund, it's not a bad idea to have a cash savings, and 4% is a lot more than you can get at most banks, so why not keep the bonds?

Bottom line is, if you forsee a need for that money in the next, say, 5 years, I would keep it where it is and then use it for a major purchase (house down payment, car, furniture, appliances, etc). If not, I would go ahead and put it in the stock market, whether in your Roth or outside of if (once it is funded for the year).

[Lolita]

Stock market is the way to go. Now is the perfect time too. There has been so much gloom and doom over the past 6 months in the media about the economy but over the past 2 weeks, the news is starting to look a little more positive. Overall, stocks are all way down. Why not drop it in there now while the gettin is good?

[Kevin]

I'd cash them out and put it into a Roth IRA, over 40 years that tax advantage will be huge.

[Alex]

Bottomline is this: it boils down to your investment horizon.

If you're considering putting them in an IRA then it seems obvious that you have a pretty long horizon (a fact that is also borne out by your age). For that reason, you should focus less on short term market volatility and more on the return differential between the alternative asset classes.

Over a 40-year holding period, the returns from holding stocks will likely far exceed the 4% that you're currently getting from the bonds.