The U.S. consumer price index, or CPI, rose by 8.2% in September, remaining near its highest levels since the early 1980s. For Americans concerned about falling stock prices and soaring inflation, U.S. I bonds may be an attractive option.
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The U.S. Department of the Treasury recently announced I bonds will pay a 6.89% interest rate through April 2023. The current yield on I bonds is down from a peak of 9.62% during the previous six-month period, but I bond yields remain higher in 2022 than they have been since 2000. These I bonds are protected against inflation and backed by the U.S. government, making them essentially risk-free investments. A risk-free 6.89% yield may seem too good to be true, but there are several caveats investors should understand before going all-in on I bonds:
— What are I bonds?
— What investors need to know about I bonds
— Are I bonds right for you?
What Are I Bonds?
Series I savings bonds are bonds issued by the U.S. Treasury that earn interest based on combining a fixed rate and an inflation rate. The fixed interest rate on the bonds remains the same for the life of the bond and is announced twice a year by the Secretary of the Treasury. The fixed rate is applied to all I bonds issued over the following six months. I bond fixed rates are announced on the first business day of May and November each year.
The inflation rate for I bonds is also set twice a year, in May and November. The inflation rate is based on the most recent CPI reading.
The fixed rate on I bonds has been as high as 3.6% back in May 2000 but is currently just 0.4%. Investors can see the entire history of both fixed and inflation I bond rates in this chart.
I bonds earn interest for 30 years, but investors can cash them any time after they are 12 months old. If an investor cashes an I bond before five years, the investor will lose the last three months of interest.
Americans can buy electronic I bonds online through the TreasuryDirect website or purchase paper I bonds when they file their federal tax returns. The maximum purchase limit per person for electronic I bonds is $10,000 per year, and the maximum purchase limit for paper I bonds is $5,000 per year.
On Nov. 1, the Treasury announced the composite rate for I bonds issued from November 2022 through April 2023 is 6.89%. Those bonds have a 0.4% fixed rate and a 6.49% inflation rate.
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What Investors Need to Know About I Bonds
Daken Vanderburg, chief investment officer for MassMutual Trust Co., says I bonds are an excellent opportunity for investors given cash is a terrible asset to hold during times of elevated inflation.
“I bonds can be a great tool for investors looking to mitigate the damage of inflation,” Vanderburg says.
He says investors holding cash are essentially losing 8% per year in the current environment.
“Unless needed for short-term liquidity, or for emotional ballast, cash is guaranteed to lose purchasing power at the current rate of inflation,” Vanderburg says.
Darren Colananni, wealth management advisor at Centurion Wealth Management, says investors should also be strategic about when they sell I bonds. For example, an investor who has held I bonds for less than five years may be tempted to sell immediately if the variable rate were to drop sharply to 2%, but Colanni says knee-jerk selling could be a costly mistake.
“Instead, let’s hold the I bond for 3 more months at the low 2% interest rate. Therefore, when we sell the bond, we will only lose the 3 months of interest at 2.00%,” Colanni says.
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Are I Bonds Right For You?
Once investors understand the risks and requirements associated with I bonds, some investors may see them as an excellent way to hedge the purchasing power of their cash during periods of rising or high inflation. However, CPI inflation appears to have peaked at around 9% in June, and the Federal Reserve is likely to continue to aggressively tighten its monetary policy to get inflation back down near its 2% long-term target.
Greg McBride, chief financial analyst at Bankrate.com, says the headline returns on I bonds can be deceptive given the majority of the 6.89% rate is variable.
“When inflation falls back to 2%, your I bond will be earning 2%,” McBride says.
Given the minimum holding period of one year and the penalty associated with selling before five years, McBride says many investors may be better off putting their cash elsewhere.
“If your emergency savings is light, an I bond probably isn’t a high priority,” he says.
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I Bonds: Lock in Nearly 7% Yields as Stocks Plunge originally appeared on usnews.com
