Series I Bonds have been a hot topic lately. The rate from May 2022 through October 2022 is 9.62%. This seems appealing and I have fielded a lot of questions about it, so here is information about how they work and when they may be appropriate to use.
How they work:
Series I bonds are savings bonds that are effectively “risk free” since they are backed by the U.S. government. The stated interest is compounded semiannually and is made up of a combination of a “fixed rate” and an “inflation rate.” The fixed rate never changes, but the inflation rate changes every 6 months based on CPI-U.
Example: the current fixed rate of 0% + the current semiannual inflation rate of 4.81% = 4.81%. Since that is the semiannual rate, the stated composite rate for the year as 9.62%.
You can redeem your bonds after 1 year, but if you redeem them before 5 years then you lose 3 months of interest. You can purchase up to $10,000 of I-Bonds per person per year.
Series I Bonds, in our view, are not appropriate long-term investments
Given the current interest rate, I-Bonds certainly seem appealing for a long-term investment but, in our view, they are not.
The 9.62% interest rate looks high; however, the *real* interest rate is about the same as it has always been… effectively zero – or negative when taxes are taken into account (the “real interest rate” is the actual rate once it is adjusted for inflation).
This is because the rate of the bond adjusts semi-annually to match inflation. It could go up to match higher inflation or go down in line with historical averages. You are rarely exceeding inflation, so the purchasing power of your funds is not increasing. Worse, federal income tax is owed on the bond interest, so your after-tax real return will usually be negative.
When it comes to protecting and growing the purchasing power of your dollars over the long run, 90+ years of market history shows that stocks still beat bonds.
When are Series I Bonds appropriate?
If our clients intend on making a large purchase within the next 5 or so years, we coach them to keep those funds accumulating in cash. This way they will not experience the short-term gyrations of the stock market. Remember, you must hold your I-bond for at least a year. If your purchase is 1-5 years on the horizon, I-Bonds can be great for that.
Even though they do not fully protect your purchasing power, they will slow the eroding effects of the current levels of high inflation. Note that the historical average of 3% inflation will cut the purchasing power of your dollars in half in about 20 years. At current levels, your purchasing power will be cut in half in less than 8 years. I-bonds can slow this effect down.
How to buy
You can’t use a brokerage account or advisor to purchase I-Bonds. They must be done on the government’s website, treasurydirect.gov. The website is a bit clunky and archaic, so be sure to keep good records of your purchase so you don’t forget about your bonds.
If you would like to further discuss I bonds or your investments, please use the contact tab to reach us.