Series I Savings Bonds, or I-Bonds, are paying a record 9.62% interest rate through October 2022. Unlike high-yield bonds that offer similar interest rates, I-Bonds are backed by the U.S. government, they don’t lose value and they pay monthly interest. As a result, they offer some of the highest risk-adjusted returns available in today’s market.
Let’s take a look at how I-Bonds work under the surface – with some caveats to keep in mind – and how to add them to your portfolio.
Don’t forget to check our Fixed Income Channel to learn more about generating income in the current market conditions.
How I-Bonds Work
I-Bonds have an interest rate that combines a fixed rate of return that remains the same throughout the life of the bond, along with a variable inflation rate that’s calculated twice per year. The variable inflation rate is calculated based on changes in the non-seasonally-adjusted Consumer Price Index, or CPI-U, which includes food and energy prices.
The bonds pay monthly interest that’s compounded semiannually. Every six months, in March and October, the interest the bond earned during the previous six months is added to the principal value, and any additional interest for the next six months is calculated using the adjusted principal. The interest and principal are paid out when you cash the bond.
I-Bonds differ from the more commonly known Series EE Savings Bonds, which pay a fixed 0.1% interest rate and are guaranteed to double in 20 years. While EE Bonds don’t have any inflation adjustments, they do rise alongside broader interest rates. For instance, they offered a 3.50% interest rate in May 2005 before the 2008 financial crisis sent rates to near zero.
I-Bond Drawbacks
The biggest drawback of I-Bonds is that you have to hold them for at least one year, and if you cash them before five years, you lose the previous three months of interest. For example, if you cash an I-Bond after 18 months, you only get the first 15 months of interest. As a result, you may want to look elsewhere if you have short-term cash needs.
I-Bond interest rates could also move lower if inflation starts to fall. While the Federal Reserve is raising interest rates from historic lows to combat inflation, recent surveys suggest that inflation will still be around 6.6% in March 2023. As a result, investors buying now would likely see at least a year of elevated returns, although perhaps lower than 9.62% after October 2022.
Many investors use I-Bonds as alternatives to certificates of deposit (CDs). With CD interest rates hovering around 1.5%, I-Bonds offer significantly more yield and a similar risk profile. They are also a way to diversify the fixed income portion of a portfolio, although the $10,000 limit and the fact that interest rates could drop in the future limit their value.
How to Buy I-Bonds
Individuals can purchase up to $10,000 worth of I-Bonds each calendar year through TreasuryDirect. In addition, you can purchase more I-Bonds through businesses, trusts, or estates with $10,000 limits for each. As a result, married couples can purchase $20,000 in I-Bonds total, helping diversify the fixed income portion of their portfolios.
If you already own I-Bonds, you should evaluate whether it makes sense to cash them in to acquire new bonds. For instance, in May 2021, new I-Bonds had a 3.54% rate. In November 2013, new I-Bonds had a 1.38% rate. However, in May 2021, the November 2013 bond had a 3.74% rate that was higher than the May 2021 bond.
You can also purchase up to $5,000 worth of paper I-Bonds when filing a federal income tax return.
Be sure to check our Portfolio Management Channel to learn more about different portfolio rebalancing strategies.
The Bottom Line
I-Bonds offer investors a compelling yield in today’s environment, particularly since they’re almost risk-free. Many investors are using them to replace CDs and other short-term savings, while others are diversifying some of their conventional fixed-income holdings. With inflation expected to remain above 6% for the next year, they could continue to perform well.
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