I Bonds
This month we continue our conversation around end of year financial planning by discussing an investment opportunity that has grown in popularity lately, but is still relatively unknown, I Bonds.
Series I Savings Bonds (often called I Bonds) are government savings bonds issued by the US Treasury that offer inflation protection. They are guaranteed to maintain purchasing power for up to 30 years.
Due to the recent spike in inflation, I Bonds provided as much as 9.62% (annualized) over the previous six months. This led to so many people flooding the Treasury Direct website to purchase them last week that the site (antiquated in its design) could not process orders.
What is an I Bond?
Here are a few of the critical features:
- They are tax-deferred federally, tax-free locally, and interest is earned for 30 years.
- They’re sold in increments of as little as $25 and up to a maximum of $10,000 per person per year when purchased electronically.
- An additional $5,000 is available only using a tax return and receiving a paper issue.You can then convert these paper bonds to electronic.
- They earn a fixed rate and a variable rate (inflation-adjusted).
- As of November 1st, the fixed component is now 0.4%.
- The variable rate as of November 1st is 6.89%.
- This rate resets in May and November every year.
- They’re not redeemable in the first year.
- There is a penalty of three months of interest if redeemed before year five.
- Example: If you cash in your bond after two years (24 months), you will only receive the first 21 months worth of interest.
- The interest can be tax-free if used for education expenses, pending income limitations.
While the above information is a good overview, we would encourage you to read more from sources linked throughout the writeup.
So, who should buy them?
I Bonds should always be evaluated as an option for the fixed income portion of your portfolio and are a suitable default place to stash emergency funds. However, many folks are herding into them based on a recent inflation adjustment, which may represent a misconception or a short-term mindset. They are an incredible asset, but you can only expect to earn the fixed rate offered (which, before this recent reset, was 0%) in real terms over your holding period.
One crucial difference between I Bonds and Treasury Inflation-Protected Securities (TIPS) is that I Bonds cannot decline in value. TIPS have a floor of getting back our par value, but the previous gains on inflation can decline. Another way to say this is that I Bonds do not take interest rate risk. TIPS may have a higher fixed rate (as of today, the 10-Year TIPS rate is about 1.5%).
When inflation was low and stable for a decade, I Bonds appeared to have been a secret. Part of the blame goes on Advisors, who, unable to earn fees on them, were unaware that they existed. Given the high, virtually ‘risk-free’ nominal yields, they are in the headlines now. Will investors continue to maximize their I Bond purchases if inflation subsides? They probably should if they do not mind navigating the website independently.
In summary, I Bonds can be a useful investment for just about anyone who owns any sort of fixed income position. They may be a little bit more of a hassle to purchase, but can provide some good long-term value to many portfolios.
Did You Know?
The first Series I Savings Bond was issued in 1998. The artwork on the original I Bonds honored people like Helen Keller, MLK Jr., and Albert Einstein to name a few.
Quotable
“If you find yourself stimulated in any way by your portfolio performance, then you are probably doing something very wrong. A superior portfolio strategy should be intrinsically boring”
–William J. Bernstein
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