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.
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| 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.
