Definition of Savings Bonds
What are savings bonds? Savings bonds are investment products issued by the U.S. government.
Essentially, they allow an investor to lend some of their money to the U.S. government for a set amount of time in return for a guaranteed repayment with interest.
Savings bonds are considered one of the most stable investments a person can make because the promise of repayment is coming from the federal government itself, as opposed to a corporation.
The U.S. Treasury would have to collapse before investors would be faced with a situation where their saving bonds don’t get repaid. This gives investors a lot of confidence in this type of investment.
However, because there is always a trade-off between risk and reward in investing, it also means that the rate of return on this type of investment is typically quite a bit lower than the rate on riskier investments.
What Is a Coupon Rate?
When you buy a savings bond, the coupon rate tells you how much interest the government is going to pay you in return for lending them your money.
“Coupon rate” is simply bond terminology for “interest rate.”
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Often, to get the most interest from the government, you will have to let the government keep your money for a certain amount of time. For instance, in the “EE/E category savings bonds,” if you redeem your bond before you’ve owned it for 5 years, you have to pay a penalty worth the equivalent of 3 months of interest.
What Is the Term on a Saving Bonds?
The term is how long the government has to pay you back your money. Essentially, when the treasury issues savings bonds, it offers them with a minimum and maximum term of ownership.
On savings bonds, the minimum term is 1 year, and the maximum is 30 years. That means that you must keep your bond for at least a year before you can redeem it.
Savings Bonds as Investments
The main reason that investment professionals like to utilize savings bonds is as a hedge against the risk present in most other types of investing.
Any time you invest in a stock, you have a potential risk of losing all your money. If a company goes bankrupt, your investment will be a total loss.
However, to not get repaid on a savings bond means that the U.S. government would need to go bankrupt, which does not appear very likely at the present time.
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Savings Bonds as Fixed Income Products
In general, bonds are known as income generating products. Certain types of savings bonds generate cash because they pay out the interest owed to you in cash every 6 months.
“Category HH/H savings bonds” pay interest in this way. If you invest in other types of government bonds, the interest is paid out in different ways.
For instance, the “I category savings bonds” accrue interest and is paid out when you cash in the bond or when it matures.
There are also some tax benefits to be had if you use the income from bonds to pay for education.
Income generated from “I-bonds” or “EE category bonds” is exempt from taxation if used to finance post-secondary education.
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