9.62% return guaranteed? Not so fast!

The following blog post was written in collaboration with our interns, Brady Gray and Mauria Ferrell.

"I Bonds" have been in the news lately as a high yielding perfectly save savings vehicle. Do you need them in your portfolio? Let's talk about it.

A Series I Savings Bond is a savings bond issued by the U.S. Treasury. The interest it pays is determined by two things: a fixed rate for the life of the bond and the inflation rate calculated twice a year. Once you purchase the bond, it will earn interest for 30 years, unless you cash out of it before then. 

As of May 23rd 2022, the current fixed rate on I Bonds is 0%. The inflation rate is 4.81% for six months, or 9.62% annualized. The interest is a combination of a fixed rate and an inflation rate. If purchased before November 1st, 2022, the interest rate will stay at 4.81% for the first six months that the bond is held. An individual can buy up to $10,000 worth of bonds annually and you can purchase an additional $5,000 with your tax refund. There are a few ways to exceed this limit, but for all practical purposes, this is the limit.

Before you purchase an I Bond there are some things you should know. You must own the bond for at least 5 years to receive all of the interest. You can cash out the bond after one year, but if you do, you will pay a penalty of the last 3-months' worth of interest. For example, assuming the inflation rate stays at 4.81% for the second six months if you purchase a bond today and cash out after 12 months, your net interest rate will likely be 7.22%, since you have the 3-month interest penalty. This is an excellent rate on any savings! If inflation drops to 0%, your 5 year return will be limited to the initial 4.81% - the equivalent of a 0.94% annual interest rate. This is not a great interest rate.

I Bonds are guaranteed and have a tax-deferred inflation adjusted interest. While the fixed rate is currently 0%, you are guaranteed to preserve your purchasing power, as measured by CPI, when you invest in these. You can buy up to $15,000 in per person, per calendar year, including electronic and paper bonds. If you have a trust or an LLC, you may be able to buy even more through those entities. They accumulate interest, and you can cash them in during retirement to make sure you have safe, guaranteed investments available. 

What could go wrong? Keep in mind, the interest paid out on these savings bonds is based on two things: a fixed rate and inflation. The fixed rate is 0%, so if inflation does not stay high, you may end up with a sub-par interest rate overall. If inflation continues to stay high – you’ll be a genius. Over the past 10 years, the inflation rate paid out has bounced around, but mostly stayed below 1%. For what it is worth, the market expectation for inflation over the next five years is 2.8% but you can get a five year CD yielding 3.2%.

Series I Savings bonds are a perfect hedge against CPI, but is that what you need? The limitations on purchasing and withdrawing must be considered. If you are looking for cash back fast, then this investment is not for you. If you have an extra $10,000 laying around and you are willing to wait at least 5 years to cash out, then this would be a good investment for some safety cash. For smaller portfolios or cash needs that are shorter than 5 years, accessibility, not inflation protection, may be a bigger concern. For cash needs that are much longer than 5 years, you may want to look towards investments, like stocks, which historically have a good chance of exceeding inflation.

We always recommend that people have cash on hand to handle emergency needs and this may be an interesting part of that long-term cash portfolio. While the withdrawal restrictions do not make it ideal for a true emergency, over time, you can build up a reasonably accessible account that may beat the rate you get at the bank right now. If you like chasing down the highest savings on an online account – you’ll love I Bonds!

When is the trade off worth it? We ran some numbers, and currently, savings accounts are awful. While you can't beat daily access without penalty, we would need to see interest rates go sky high to make them worth it if the inflation rate stayed at 9.62% over the next five years. CDs, on the other hand, can be found with decent rates, above market inflation expectations. If the inflation rate returns to about 1.5% - higher than it has been over the last few years, a CD at 3.2% is more attractive.

This compares a CD at 3.2% to inflation declining to 1.5% after the first year.
Scenario 2 compares inflation at 9.62% for five years to a savings account increasing to 18%! 

Treasury Series I Savings Bonds are not for every portfolio. The current interest rate and government guarantee are VERY attractive features right now, but you have to consider this in the context of your entire portfolio and financial life. The decision to invest is less a matter of speculating on inflation rates, and more a matter of considering your future needs. If you do want to invest, open an account directly at TreasuryDirect.gov to get started.

The Economy and the Stock Market: How are They Related?

 The following blog post was written by our interns, Brady Gray and Mauria Ferrell.

What is the economy and what is the stock market and what do they have to do with each other?

 

The economy is all of the goods and services in the US. We measure the economy in terms of Gross Domestic Product (GDP) which is the dollar value of all of those goods and services. 

 

The stock market is where the buying and selling of shares of publicly held companies takes place. A stock is a share in ownership of a company. Companies allow people to purchase stock so that they can get the capital they need to invest in new projects or machinery. Just over half of the U.S. population owns some stock. The stock market is forward looking: The price moves reflect how investors feel about the future of these companies based on economic expectations.

 

So, how do we measure the economy and the stock market’s performance? It is important to remember that they do influence each other, but they are not the same thing.

 

When looking at the economy we generally consider 3 key indicators. These indicators are the unemployment rate, consumer price index, and gross domestic product (GDP). If GDP is rising, that means the economy is growing. A falling GDP indicates that companies are producing fewer goods and people may lose their jobs. A recession is generally defined as a decline in GDP over two quarters – a shrinking economy. 

 

As far as stock market performance, there are many indexes that follow the overall direction of the market. For instance, the S&P 500 tracks the performance of the top 500 largest publicly traded companies. While there are thousands and thousands of stocks out there, the stocks in this index represent a very large portion of the market’s overall value.

How are the stock market and the economy related? When GDP is growing, individual businesses areproducing more and expanding. A rising stock market is usually aligned with a growing economy and leads to greater investor confidence, which leads to more buying activity. When consumers buy more, businesses produce and sell more goods and services. All of this results in a higher GDP.

 

While the economy and the stock market are different, they influence each other in various ways. The stock market alone is not an indicator of economic health, but good economic health can positively influence the stock market. We use key indicators like GDP, consumer price index, and unemployment rate to tell us the true health of our economy. So, next time you go to invest in the market, keep in mind how the market and the overall economy are working together.

The graph below shows the total value of the stock market as a percentage of GDP (FRED).

What is money?

The following blog post was written by our interns, Brady Gray and Mauria Ferrell, in response to a question we received on the radio this week. You can listen to the full show here. 

Money, by definition, is anything that is accepted as a form of payment in exchange for goods and services in a particular region. The official currency in the United States is the U.S. Dollar (USD) and its value is guaranteed by our federal government. Cryptocurrencies, however, are not backed by any nation’s government. This can make Cryptocurrency more volatile and riskier in general. It is important to understand that the Federal Reserve is the central bank in the U.S., and it controls how money moves, known as monetary policy. 

The U.S. Dollar and the amount of money in circulation is controlled by the Federal Reserve. This along with adjusting interest rates is referred to as monetary policy. The Federal Reserve actively analyzes the state of the economy and creates or destroys money as needed. Now, when they say “destroy”, it does not mean literally shredding up paper bills. They can take money out of circulation by changing short-term interest rates and by adjusting bank’s reserve requirements. Both of those actions will decrease or “destroy” money. On the other hand, if they wanted to “create” money, or increase the supply, they would just do the opposite. For instance, we saw towards the beginning of the pandemic, record low interest rates and stimulus payments from the federal government. Note that stimulus payments were not part of monetary policy, but rather a form of fiscal policy controlled strictly by the federal government. Very low interest rates encouraged spending in the economy. Many Americans bought new homes, cars, and other things while the cost of financing was at record low levels. Today we are seeing effects of those past events. The economy started to grow at never-before-seen levels and the policies did not change in time. Inflation is currently at 8.3% as of April 2022. Inflation is the term used when the purchasing value of money decreases. 

            

Another form of currency that has recently surfaced over the past decade is cryptocurrency. It is not specific to one country or region, nor is it backed by one. Instead, crypto uses a technology called blockchain. Blockchain is a specialized system that records all transactions made with cryptocurrencies. It utilizes several computer systems across the world to keep accurate records. As I mentioned before, cryptocurrency is generally riskier due to the fact that there are many unknowns. How do we know for certain that a coin holds the value that it claims it does? It is a great question; any many people wonder the same about the U.S. Dollar. They think that a U.S. Dollar may not have value because it is no longer backed by the gold standard of the 1960s. The difference here is that the U.S. Dollar is backed by our federal government. A one-dollar bill is recognized by everyone across the world as a ligament currency that holds its value of one dollar. With cryptocurrency, you have to believe that a specific coin is worth the amount shown. No one can prove or assure you the value of that coin. 

Can we consider cryptocurrency money? Let's look at what happened with Terra. Terra is a "stablecoin," which is a cryptocurrency that is intended to have a fixed value, typically $1. Given their intended stability, they are meant to provide more reliable store of value and medium of exchange. Terra's recent downfall however lets us know that cryptocurrencies are not quite ready to be considered money. 

Priceless Knowledge

My dad will be 93 in August. Finally, he agreed to use his cane regularly since his balance and agility have suffered. Other than that, he manages fairly well. He still drives. He cooks. He handles his own finances… with a very tight fist!

 

Last year, my mother passed away. During her decline, I began questioning my father about their finances. I asked him for a list of assets and income. He said he’d give those to me, but he never got around to it. I needed those numbers to have discussions about their care and living arrangements, and I AM a financial advisor. It’s what I do, but I was having trouble helping my own family.

 

Every family is different, but most have a difficult time leaping from the all-knowing, all-providing parent to the new relationship that requires dependence on a grown child. Money is an intimate subject, and some families just aren’t good at broaching that subject. Some parents may be embarrassed by their lack of resources. Some may just be concerned about giving up control.

 

But broach it we must. Generally, I encourage clients with grown children to begin eking out details about their financial lives. The older the parent, the more important it becomes to share information. And maybe not all offspring need to know everything, but the full picture should be known by at least one person.

 

If you are the grown child of an aging parent, how do you encourage your parents to share financial information? Schedule a quiet time to talk. Don’t ambush them at Thanksgiving. Make it a time outside of the big family gathering. Tell them you want to learn about their situation and offer any help they may need. Give them time to gather details about all accounts. 

 

Whatever they put in front of you, keep your surprise to yourself. For many grown children, it’s a shock to see their blue-collar parents’ sizable portfolios. Yes, you may express admiration for their fiscal management. And you should probably make sure they understand the purpose of those funds is to care for themselves, not to leave money to family. But, of course, they will still want to do that.

 

And if the list is meager, be calm and straightforward. Their funds may limit their choices in old age, and everyone should be realistic. Get educated about assistance options—Medicaid, Veteran’s Benefits, etc. The better you are at researching options and processing forms, the better off they’ll be. Don’t assume assistance will happen automatically. Somebody has to make it happen, and it will probably be you.

 

My dad finally gave up the list. Opening the door allowed us to have honest discussions about what would be best for him. I think it was a relief for him to finally share that information. I know it was a relief for me as we began planning for the “what’s next” part of his life. He went through the legal paperwork to name me as power of attorney. He began consolidating and simplifying his accounts.

 

This week, we moved him into assisted living. After my mother’s death, he recognized the risks of living alone. A minor fall shocked him into action. He also recognized the need for more social interaction. Because I knew his financial situation, I could help with this transition knowing it was sustainable. He’s still paying his own bills and handling all his own financial decisions, but I know he’ll be okay. That knowledge is priceless.