With all the juicy financial headlines—stock market movements, inflation, the housing market, student loan conversations, etc.—who would have thought that bonds would have their moment in the sun?
Bonds have a reputation for being the safe and stable alternative to risky, daredevil stocks. Their reliable returns and ability to produce income make them integral in any well-diversified portfolio but typically keep them out of the spotlight.
But in this high-inflationary market, one type of bond, in particular, is getting a lot of attention: the Series I Savings Bond.
- What’s an I-bond?
- How can I-bonds help you out during high inflation?
- Does investing in I-bonds make sense as part of your strategy?
Yes, Bonds Are Still Relevant
Bonds are like a fancy IOU (or a debt security). When you buy a bond, you give a loan to the company or government. That institution promises to pay you back in full with interest over a set period.
You’ve probably heard people say that bonds are fixed-income securities, and all that means is that they pay a fixed interest rate to investors—though some bonds pay variable interest rates as well!
What’s great about bonds is that they act as a cushion for your portfolio. Stocks and bonds tend to react differently to market conditions, so when stocks are wobbly, bonds are there to pick up the slack. Bonds also generate income, making them a flexible part of your long-term cash flow plan.
While bonds are an essential component of investing, it’s important to note that inflation and bonds typically don’t get along, which isn’t good news for today’s investors.
Since inflation reduces purchasing power, the bond’s real return suffers. So, if a bond pays a 5% yield, but inflation is at 4%, the real inflation-adjusted yield is only 1%—yikes.
As you know, inflation is at record levels. You’ve probably felt the inflation growing pains at the grocery store, filling up your gas tank, and purchasing everyday items. The most recent data from the Bureau of Labor Statistics pegs inflation at 8.5%, something the country hasn’t experienced in over 40 years.
Remember, bonds and inflation aren’t best friends. With inflation so high, people are concerned about the long-term value of their bonds.
But that doesn’t mean you should discount all bonds from your investment picture. I-bonds can be an excellent inflation hedge; here’s why.
What’s An I-Bond?
The U.S Treasury Department issues Series I Savings Bonds or I-bonds. These bonds are backed by the full faith of the U.S government, so they’re one of the safest bond securities on the market.
I-Bonds, The Basics
I-bonds are “non-marketable,” meaning you can’t buy or sell them on secondary markets like the stock exchange.
You can purchase them electronically via Treasury Direct or use your tax refund to buy a set amount of paper certificates. Every individual can buy up to $10,000 in electronic I-bonds per year. Plus, you can redirect up to $5,000 of your tax refund to purchasing these bonds (if you do this, you’ll actually get a paper bond).
I-bonds last for 30 years unless you decide to cash them in sooner (and there are many reasons why you might). Once you purchase an I-bond, you can’t sell it for at least a year. Like a CD, you lock your money in for a set period and earn higher interest payments in exchange.
While you can cash in the bond after one year, you forgo the previous three months of interest accrued if you sell it before you’ve owned it for five years. So, if you cash your I-bond at 20 months, you’ll only receive 17 months’ worth of interest.
I-Bonds and Interest
An I-bond earns interest monthly, and it compounds semi-annually. You will have to pay federal, but not state, tax on the interest from your I-bond. You can choose to report the interest annually, or in the year you cash out the bond, whichever is most advantageous for you.
The I-bond’s claim to fame is its ability to help your money keep up with inflation. How does it work? I-bonds offer two types of interest rates.
- Fixed: Remains the same for the bond’s life—30 years.
- Variable: Inflation-adjusted every six months on May 1st and November 1st
Currently, the fixed interest rate for I-bonds is 0%. While that number isn’t all that exciting, the next one assuredly is.
The Treasury Department just announced that the new variable interest rate for I-bonds issued between May 2022 and October 2022 is 9.62%!!! That means you will want to purchase these bonds before Nov. 1st if you want to get in on the 9.62% interest rate for 6 months.
That’s more than a whole percentage point higher than present inflation rates and a far cry above savings accounts. The average high-yield savings account is only paying 0.60% interest currently. So if you’re one of those people who has been complaining about how low the rate on your savings account is, then I-Bonds are for you.
Once you see the numbers, it starts to make sense why I-bonds are turning heads. I-bonds are a safe place to store cash that you won’t need for a while—anywhere from a year to 30 years in the future.
Since the variable interest rate for I-bonds is tied to inflation, the numbers are some of the highest on record.
So when inflation goes up, the variable bond yield will likely follow suit. But when the market cools, I-bonds won’t boast these high numbers. A silver lining is that unlike other types of bonds that can produce a negative yield, I-bonds can’t yield less than zero.
When the interest rate on these bonds starts to go down to a yield you’re no longer comfortable with, you can move this money to other investments, such as a more diversified stock portfolio.
“I” Is For Inflation
Inflation sits at historical highs, and investors are looking for ways to keep up. With savings accounts falling short, I-bonds are quickly stepping in to fill the void.
But while you may just be hearing about these types of savings bonds for the first time, they’ve been around for years; the government issued the first one in 1998.
When the then-Vice President Al Gore introduced I-bonds at an official ceremony, he was hopeful that these vehicles would help families save for retirement and their children’s education without worrying about inflation’s impact on their future purchasing power.
Some clients are wondering about other ways to save for their children’s future outside of 529 Plans, and I-Bonds are a great tool for that. You can set up a custodial account on the Treasury Direct website under your profile.
When you invest in I-bonds, you have a safe vehicle to weather the rough storm of inflation, which has worked well for many families, even though these types of bonds are just now finding their way back into the spotlight.
A Safe Investment With Good Returns, Is This For Real?
I-bonds have the U.S government’s seal of approval, which makes them the “gold standard” of safety. You’ve also learned that these bonds offer competitive interest rates in a rather tough moment for inflation.
You might be asking,
What’s the catch?
Plus, you could be a bit on edge after exploring the Treasury Direct website, which frankly looks like it could be fake with the funky layout and 90s color scheme.
Don’t worry; I-bonds are a totally real and compelling way to invest in protecting your money against inflation safely.
It makes sense to be more careful about your investments, especially in the current market landscape. Still, I-bonds could be a great way to keep up with (or even beat) inflation without relying solely on equities.
While most investors can purchase I-bonds from Treasury Direct with no issue, sometimes there’s a snag in the plan. You might be asked for ID verification before purchasing your bonds, and to do that, you’ll need to get a signature guarantee to ensure you are who you say you are.
A signature guarantee is really like a notary public. You have to find a “certifying officer,” like someone at your bank, and go through the following steps.
- You sign the piece of paper in front of the selected officer.
- After verifying your identity, the officer signs it.
- You mail the signed document.
- Voila! You are good to go.
Once you send the form to the Treasury Direct, it will likely take a few weeks to process.
Unique I-Bond Strategies To Consider
What role could I-bonds play in your investments?
Let’s take a look!
Since you can buy an absolute maximum of $25,000 worth of bonds each year (for a couple), this is a strategy you can use year-over-year. By accumulating the bonds slowly, you give yourself more room in your present and future cash flow.
Another exciting application of I-bonds is for your child’s education fund (as the government hoped for). For example, you could set up an I-bond for each of your children that they would use for various goals in the future, like additional college expenses other than tuition/room and board, a down payment on a home, a wedding, etc. Think about this in conjunction with investing in a 529 Plan.
Using I-bonds is another excellent strategy for grandparents to consider doing for their grandchildren. Many grandparents have a goal to be financially present in their grandchildren’s life, and what a gift it could be to give them this bond that they could use in the future.
As you can see, I-bonds can be an attractive investment in times of high inflation. They offer a safe and reliable way to invest while still insulating your funds from inflation. There are many ways you could use I-bonds to help you reach your money goals. If you have any questions about them, let’s talk!
