Highlights:
- Inflation is at a decades-long high.
- Interest rates are at historical lows.
- Most investments do not keep up with inflation, so investors are falling behind.
- One possible solution is I Bonds, which currently offer a 7.12% interest rate.
I bonds are U.S. inflation-protected bonds. The U.S. Treasury created them as a means to help investors save for retirement and protect their savings from inflation. These bonds, like all U.S. savings bonds, are ultra-safe securities since they are backed by the full faith and credit of the U.S. government.
Interest payments on I bonds are unique in that they are determined by a fixed rate of return plus a variable rate based on inflation, as measured by the Consumer Price Index, or CPI. The fixed rate of return is currently set at zero, so interest payments are equivalent to inflation which right now is 7.12%.
Interest rates are set and compounded semi-annually. So, six months from when you buy the bond the interest rate payment will reset and be equal to prevailing inflation rates. As inflation normalizes yields will fall, but by investing today investors can lock-in a 3.56% interest rate.
This is significantly higher, as well as significantly safer, than most bonds and equities. For example, the S&P 500 currently yields 1.30% and is down 7.3% YTD, while I Bonds yield 7.12% and have suffered / will suffer 0% in capital losses.
The most significant consideration is the fact that future interest rates and payments are dependent on future inflation rates. Falling inflation means lower yields, which would impact the value of these securities: there is no point in buying an inflation-protected security if inflation collapses. However, this is not a significant risk, as investors can lock-in a 3.56% interest rate payment if they buy these securities from now until April 2022. Lower inflation would reduce yields, but there is a floor at 3.56%.
There is a purchase limit of $10,000 of I bonds per person, per year. I Bonds must be held by investors for at least one year. If held for less than five years, investors lose the previous three months of interest. These last two stipulations make I bonds inappropriate for short-term investors who need or desire liquid, short-term investments. However, I bonds’ high yield and low risk make them strong investment opportunities particularly appropriate for income investors and retirees.
What is the best strategy for investing in I bonds? The most logical course of action is to invest in the bonds until inflation drops, then sell. From now until April 2022, the interest rate is locked in at this 3.56%. If future inflation is low, the strongest returns come from investing in the bonds, collecting the guaranteed 3.56% interest rate payment, and selling soon after the required 1 year. If future inflation is high, the strongest returns come from investing in the bonds for a long time, so as to collect as many high interest rate payments as possible.
If this sounds intriguing to you, or you have any additional questions, contact our office. We would love to discuss I bonds with you as part of your investing strategy.
All investments involve the risk of potential investment losses and no strategy can assure a profit. Please note that individual situations can vary, therefore, the information presented here should only be relied upon when coordinated with individual professional advice.