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BILLIONS OF DOLLARS poured into Series I savings bonds toward the end of October, as investors rushed to snag the 9.62% annualized rate then on offer, which was guaranteed for the first six months. But it turns out these folks were a tad too hasty.
How so? Buyers of I bonds are promised a pretax return equal to the inflation rate, plus they sometimes also get an additional fixed rate of interest, over and above inflation, depending on when they buy. For the past two-and-a-half years, that additional fixed rate of interest has been zero. Pretty much everybody—including me—assumed it would remain that way. After all, with inflation so high and with billions flooding into I bonds, why offer anything more than a fat inflation-driven yield?
But it turns out those sneaky folks at the Treasury Department had other ideas. For the I bonds sold during the six months starting Nov. 1, the annual fixed rate has jumped from zero to 0.4%. One possibility: Perhaps the Treasury Department did this because Treasury Inflation-Protected Securities, or TIPS, are now also offering higher real yields.
The result is that, for the first six months that today’s buyers own their I bonds, they’ll earn an annualized 6.89%. But what’s really guaranteed is 3.44% for six months, or 3.24% to compensate for recent inflation plus half of the 0.4% fixed rate. Thereafter, today’s I bond buyers will get a return equal to the inflation rate, plus 0.4% a year.
What if, instead, you’d bought in October? You would pocket an annualized 9.62% for the first six months, equal to 4.81% for that six-month period. That’s better—1.37 percentage points better, to be precise—than the 3.44% that November’s buyers will collect during their first six months.
But after the initial six months are over, things start to change. October’s buyers will get a yield equal to the inflation rate, while November’s buyers will get inflation plus 0.4% a year. It won’t take many years for today’s buyers to catch up with October’s buyers, and thereafter they’ll pull further and further ahead.
All this carries something of a sting. Why? You’re limited to buying $10,000 of I bonds per year, plus another $5,000 using your federal tax refund, assuming you owe that much. On top of that, you can’t sell savings bonds in the first 12 months and you lose the last three months of interest if you bail out in the first five years. Still, October’s remorseful buyers will get another chance in 2023—when they can invest $10,000 more.
I am not certain if this article is more helpful or more harmful. The comments suggest that people are engaged with the topic and therefore it is helpful. However, is it helpful or harmful to point out (in retrospect) that people would have been better waiting? Does it reinforce the notion of an optimal investment strategy that once again we failed to achieve (even though “optimal” could only be known after the fact)? Based on the comments, it seems like the calculations needed to understand the impact of the decision are complex and multiple intelligent people are coming up with different answers to the question. Is the impact of the sub-optimal decision dwarfed by the bigger accomplishments of saving enough to have $10,000 to invest and all of the benefits of Series I savings bonds that have been discussed in previous articles on Humble Dollar? One of the other comments links to this topic on the Boggleheads website. Over there, this topic makes sense. On Humble Dollar, I am not so sure.
Why is the article helpful? It seems many recent buyers of I bonds were attracted by the high nominal yield — guaranteed only for six months — while not fully understanding that they were buying an investment that would merely track inflation and, after taxes, lose ground to it. Indeed, even as billions poured into I bonds in late October, these buyers could instead have bought Treasury Inflation-Protected Securities in their IRA or 401(k) and earned a return with a healthy yield over and above inflation. November’s I bond rate announcement offered a chance to explain how I bonds work — and how buyers need to look beyond the high initial yield and think about what their long-term return will be.
Don’t tell me that you’re evaluating a transaction after the fact! If someone’s plan – without firm knowledge of the future change – was to buy the bonds in October, it’s hard to fault that. Market timing is imprecise!