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John Lim

HOW WOULD YOU LIKE to earn a guaranteed 6.7% or more on your money without taking any risk? Although it sounds too good to be true, that’s exactly the opportunity that will be offered on Nov. 1. The investment? Series I savings bonds.

I bonds are 30-year bonds issued by the U.S. Treasury, which are available to anyone who opens a free TreasuryDirect account. These bonds are the quintessential risk-free asset. Backed by the full faith and credit of the U.S. government, they have minimal credit risk. They also offer inflation protection, as their yields are indexed to inflation.

The yield on I bonds is the sum of two components: a fixed rate and an inflation rate. The fixed rate is set at the time of purchase, and remains fixed for the life of the bond. It’s currently 0%, so you can effectively ignore it.

The inflation rate component of the yield adjusts twice a year—the first business days of May and November. The semi-annual inflation rate for I bonds being currently sold is 1.77%. This determines the interest earned over the next six months. Double it and you get the bond’s annual percentage rate (APR), which would be 3.54%.

While 3.54% isn’t bad, the new rate in November is all but guaranteed to be much higher. My guess is that I bonds issued then will carry yields of at least 6.7% and possibly as high as 7.8%. Let me explain.

The inflation rate is based on the Consumer Price Index for All Urban Consumers, which I’ll simply call CPI. The November rate will be based upon the percentage change of CPI from March to September of this year. We already know March’s CPI number, which was 264.877. September’s CPI won’t be released until Oct. 13, but the August number was 273.567.

Assuming there’s no change in CPI in September—not very likely given recent trends—the six-month percentage change would be 3.28%. That corresponds to an APR of 6.56%. The effective annual rate you would earn is 6.67%, since I bonds compound semiannually.

More than likely, September’s CPI level will be higher than August’s. How much? The average monthly increase in CPI has been 0.55% year-to-date. Extrapolating that rate of increase, September’s CPI would be 275.072, corresponding to a semiannual inflation rate of 3.85%. The corresponding effective annual rate for I bonds would be 7.85%. That’s not too shabby, particularly considering this return is risk-free.

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Of course, the rate would only apply for six months. In May 2022, the rate would be adjusted once again. If the Fed’s transitory thesis is correct, and inflation slows next year, the interest rate on I bonds would fall. On the other hand, if inflation persists or accelerates, I bond yields would remain high and vastly outperform money market funds and savings accounts.

Another bonus: Unlike TIPS, or Treasury Inflation-Protected Securities, I bonds are protected against capital losses. Akin to a savings account, the principal value of an I bond can only increase. In the unlikely scenario that inflation is negative, the inflation rate on I bonds can never go below zero.

I bonds must be held for a minimum of one year after purchase. If you redeem an I bond before it’s five years old, you’ll lose the last three months of interest. Assuming a 6.67% interest rate, selling early would reduce your return for the final 12 months to 5%.

How many I bonds can you purchase? There’s an annual limit of $10,000 per individual. That means a married couple with two children could buy up to $40,000 in total. If that family had a trust, another $10,000 could be purchased in the name of the trust, for a cumulative $50,000 in I bonds per year. Keep in mind, if you buy an I bond for a child through a custodial account, that constitutes an irrevocable gift.

I bonds also enjoy favorable tax treatment. Interest is subject to federal income taxes, but is free from state and local taxes. You can also defer reporting the interest on your federal tax return until you cash in your bonds or the bonds mature. If you hold an I bond to maturity, that’s 30 years of tax-deferred growth. Speaking of taxes, you can purchase up to an additional $5,000 in paper I bonds per year using your federal tax refund.

If you’re considering I bonds, I would suggest waiting until Nov. 1, when the interest rate will reset to a much higher level. Just don’t expect most advisors to recommend them. I bonds are only available—commission-free—through TreasuryDirect.gov or when you file your tax return. As such, your advisor stands to gain little by having you invest in these wonderful bonds.

John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.

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johntlim
johntlim
6 days ago

The verdict is in. I bonds should yield 7.25% starting November 1. Enjoy the interest!

David Sperber
David Sperber
11 days ago

Is yield returned as cash? Can it be compounded?

To put numbers on it, say the first year’s return is 7.5%, so a $10,000 investment after 12 months is worth 10,750. When the next year’s inflation rates and yields are determined and applied, is it to the larger appreciated investment amount (e.g. where the prior year’s earnings are compounded)? , Basically, does it count to the 10,750, the principal 10,000, or something entirely different?

Jonathan Clements
Admin
Jonathan Clements
11 days ago
Reply to  David Sperber

The interest accumulates in the value of your bonds until you cash them in — and, yes, it does compound.

Mark Gilbert
Mark Gilbert
12 days ago

When you say, “Unlike TIPS … I Bonds are protected against capital losses,” I think you’re wrong about TIPS.
For example, “But here’s an additional advantage of TIPS: They also offer owners protection against deflation. TIPS come with a “deflation floor” that protects the holder’s principal value if the depression scare turns into a deflationary episode. In other words, if the Consumer Price Index is falling the floor guarantees the TIPS owner either the inflation-adjusted principal or the par value at maturity–whichever is greater. TIPS do not lose their value during deflation.”
https://www.marketplace.org/2008/12/01/tips-and-deflation/

Yyzguy
Yyzguy
12 days ago

What happens to the bond, (both principal and interest), if the government fails to increase the debt ceiling?

Bob Wilmes
Bob Wilmes
17 days ago

Thanks John Lim – the 6.7% yield caught my eye – so my wife and I have new Treasury Direct i Bonds as of today! I used to buy savings bonds religiously when they were in a paper format and my employer would just mail them to me. Most of them have or will soon reach maturity. Decades of tax deferred compounding added up to a significant estimated tax payment every year.

David Sayler
David Sayler
17 days ago

I’m a big fan of I-Bonds in general. As a place to part short term savings, they are hard to beat right now.

Ginger Williams
Ginger Williams
17 days ago

Since the rate resets the first of May and November, wouldn’t I-bonds purchased now go up to the expected higher rate on November 1? I’m expecting some excess cash this month, which I have earmarked for my first I-bond purchase. Is there really an advantage to leaving that cash parked in savings for a couple of weeks?

wtfwjtd
wtfwjtd
17 days ago

It all depends on how long you plan to park your money in I-bonds. Bonds purchased now will earn the current rate of interest (3.54%) for 6 months, and then will adjust to earn the announced rate in November for 6 months, and then will adjust to earn the announced rate in May for 6 months, and so on and so forth. The fixed component of the interest rate–the rate above inflation–is set for the life of the bond when purchased, and does not change (it’s currently 0%).
So, if you’re looking to hold your I-bonds for several years, there’s really no advantage to leaving your cash parked in savings for a couple of weeks. If, on the other hand, you are looking to cash out your bonds in a year or two, then you may want to leave your cash parked in savings a couple of more weeks, and then purchase your bonds in November, to avoid the lag time of when next month’s interest rate will apply to your newly-purchased bonds. Of course, if you expect May’s interest rate to be lower than 3.54%, you might want to purchase your bonds now regardless. So you’re still left with a little bit of a guessing game, it all depends on your expectations and time frame.

IAD
IAD
17 days ago

This is taken from Treasury Direct’s page. I don’t see a benefit to waiting until November 1st.

The interest is compounded semiannually. Every six months from the bond’s issue date, all interest the bond has earned in previous months is in the bond’s new principal value. Interest is earned on the new principal for the next six months. For example, in month seven, interest is earned on the original price plus six months of interest. In month 13, interest is earned on the original price plus 12 months of interest. However, values displayed by the Savings Bond Calculator for bonds that are less than five years old do not include the latest three months of interest. These values reflect the interest penalty. If you hold the bond for at least five years, when you cash in (redeem) the bond, you receive all the interest the bond has earned plus the amount you paid for the bond.

Jonathan Clements
Admin
Jonathan Clements
17 days ago
Reply to  IAD

Please see the first answer here:

https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
What interest will I get if I buy an I bond now?
The composite rate for I bonds issued from May 2021 through October 2021 is 3.54 percent. This rate applies for the first six months you own the bond.

In other words, as I understand it, if you buy today, you’ll get 3.54% for the next six months, and then the new rate (announced Nov. 1) for the six months that follow. If your planned holding period is one year and inflation subsides sharply, it may make sense to buy today. But if inflation continues at around today’s higher rate, waiting until Nov. 1 would be worthwhile (again, assuming a 12-month holding period).

Last edited 17 days ago by Jonathan Clements
IAD
IAD
17 days ago
Reply to  IAD

This is a great I-bond calculator: I Bonds Home $1,000 (eyebonds.info)

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