Last week I made a presentation to a bunch of high school students on the importance of basic financial planning skills. I had hopes that my presentation would open up a discussion on how to handle gifts, allowances and prepare for larger purchases such a college education or their first car. Yet, surprisingly, there was enormous interest in learning about EE savings bonds. That’s right. Those gifts of paper a grandparent, or well-meaning friend or relative give to a child to commemorate a life event such as a birthday, First Communion, or a Bar Mitzvah.
One student told the story about how he had a stack of $100 savings bond that he thought was worth over $2,000. He went on to explain to the class that on special occasions his grandparents bought these bonds for $50 and he was told that in seven to eight years they would reach the face value ($100) and then after that, they would double in value every seven years thereafter. At 16 years old he thought that some of his bonds might actually be worth $200.
I thanked him for sharing this personal information about his financial life, but had to ask where he had heard that savings bonds would double in seven to eight years. “My grandparents,” he replied. “You should see the stacks of savings bonds they have,” he added.
The days of savings bonds doubling in seven years have gone the way of the encyclopedia salesman, the 8-track cassette and rotary telephones. According to the U.S. Treasury Web site, EE savings bonds sold in 2008 will earn an interest rate between 2.62 percent and 0.96 percent. It’s not surprising that these interest rates are so low, considering the overall interest rate market in the United States; yet the fact that people are still buying these securities based on wrong information is troubling.
EE savings bonds are generally purchased through banks and other financial institutions. They are sold at half the face value; for instance you pay $50 for a $100 bond, but it’s the interest rate at the time of purchase that dictates when a bond will reach its face value.
This rate is determined by pegging it to the adjusted 10-year Treasury Note rate; currently about 3.4 percent and discounting it about 10 percent.
So how do you determine when your bond will reach face value? You rely on a simple mathematical formula called the Rule of 72. If you simply divide an interest rate by 72, you can determine the number of years it will take for something to double in value. So, let’s try it. 72 divided by (we’ll use 3 percent) equals = 24 years. Ouch!!
That’s right if grandma was considering the purchase of buying a savings bond for a grandchild with the intent of him/her cashing it in to cover some college costs; they might think about buying them at the same time they’re pressuring their own children to start working on grandchildren. I joke, but, I think it’s very important to recognize the world has changed, and savings bonds don’t deliver the same solutions that many people had considered in years past.
Yes, these securities are still backed by full faith and credit of the U.S. Government, and interest accrues in the bond. Taxes aren’t due until the bonds are cashed. But are they a smart long-term strategy? I’m not so sure.
But back to the boy who stood up in class to talk about the savings bonds. What about the bonds his grandparents had purchased over the past several decades? Well many of those bonds may in fact be earning interest rates of 5, 6, 7, and even 8 percent — it’s just based on WHEN they were purchased. The U.S. Treasury offers a Savings Bond Wizard. Give it a shot. You may be pleasantly (or unpleasantly) surprised at the value of the bonds you have sitting in your own underwear drawer or safe deposit box.
For further information I’d encourage you to visit the U.S. Treasury Web site: www.ustreasurydirect.gov.
Marc Freedman, CFP®