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Saturday, November 19, 2005

Saving money: I like I-bonds...

For medium-term money, my favorite way to save is the I-bond. While they aren't so suitable for short-term savings, they are good for medium-term saving, particularly if you ladder them in such a way as to avoid the penalty that occurs if you cash them in too early. Their advantages over normal savings vehicles:

o Typically higher interest rates. The I-bond has a "base rate" that is fixed over the life of the bond and an "inflation part" that adjusts every six months, based on the Consumer Price Index. The total interest rate on the bond is the base rate added to the inflation part. I-bond rates are usually 1-2% higher than the best money-market rate.

o You don't pay federal tax on the interest until you redeem the bond. You can also avoid all the federal tax on the bond if you use the bond to pay for educational expenses.

o The interest on the bonds is exempt from state income tax. If you live in a high-tax state like California, this can add up to a half-percent or more to the interest rate versus non tax-advantaged ways to save.

o You can get I-bonds for free (ie, without extra fees other than the money to buy the bond itself) from banks or from Treasury Direct.

In general, I-bonds don't pay enough to be a long-term investing strategy, but they are one of the best ways to do directed, medium-term savings.

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