How Do Savings Bonds Work? Your Questions, Answered

Updated 01/31/18
We the People Style

You're not alone if you've ever asked yourself, How do savings bonds work? It's an area of investing that can sound intimidating if you're new to the game but one that's perfect for entry-level investors. If you want to work on growing your assets with minimal risk, now's the time to do some research and turn to an expert to take control of your personal finance.

Enter Janet Alvarez, a personal finance expert for Wise Bread. Ahead, she'll explain everything you've wondered about savings bonds (and the answer to questions you're too embarrassed to ask). It turns out it's not as difficult a topic to understand as it may seem. Like any investment, it takes thought and time to reap the benefits. If you're wondering how savings bonds work, let Alvarez take you through the investment basics you need to know to take your savings to the next level.

How do savings bonds differ from other kind of investments?

Alvarez refers to savings bonds as "investment vehicles," explaining that they are offered and backed by the U.S. government. "This creates a very safe investment which offers relatively low but stable returns over a long period of time," says Alvarez. This sets bonds apart from other types of investments like stocks, which frequently fluctuate in value.

Alvarez offers a popular type of savings bond called Series EE bonds as an example. She explains that with this bond, you are guaranteed to double your investment in 20 years, the only catch is that you have to hold the bond for the entire 20 years to enjoy the reward. This is different from stocks and mutual funds, which can be sold at almost any time without penalty.

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How much money do you need to invest?

"Savings bonds are a long-term investment, so invest only funds that you won't need for a long time," advises Alvarez. Savings bonds aren't useful for saving in the short term. Instead, they're most beneficial for something like a child's college education fund. This is because you'll ideally begin saving for this long before the funds are needed.

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What are the benefits?

"Most importantly, savings bonds offer a stable, guaranteed rate of return; investors know that their money is safe, and how much it will earn," Alvarez says. Other benefits include the fact that savings bonds are free from state and local taxes, and while federal taxes must be paid, you can do so on a tax-deferred basis. Additionally, you may receive tax benefits if you use savings bonds to pay for certain education expenses. To put it simply, "savings bonds are easy to understand and simple to sell or cash-out of," concludes Alvarez.

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What happens to your money once you invest it in a savings bond?

When you invest in a savings bond, your money is held by the U.S. Treasury. However, it doesn't necessarily stay there. Once you invest, your money may be used to fulfill the needs of the Treasury, Alvarez explains.

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Are there any drawbacks?

The biggest drawback to investing in savings bonds is that this type of investment generally yields fewer returns than other investments like stocks and mutual fund. "You may miss additional investment gains," explains Alvarez. Furthermore, savings bonds are rather inflexible due to long holding periods that, if breached, result in early sale penalties, according to Alvarez.

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What's the number one mistake investors make?

"People often forget the time horizon for which they're investing," Alvarez shares. She advises you choose an investment based on when you'll need the money and how much of a risk you're willing to take. "You wouldn't invest money you'll need next week in a savings bonds, but by the same measure, you wouldn't invest your child's college fund in a highly risky stock," she says.

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