Series I bonds: an investment to protect against inflation
Series I bonds are a popular investment right now. It’s no wonder. They are meant to match the rate of inflation, with nearly no risk of loss if held for one year or more. In June 22, they are currently paying a +9.62% yield (this rate will reset in October 2022). Compared to the losses that people are seeing in their stock portfolios, or the erosive power of inflation, series I bonds may seem like a no-brainer. They may be, but if you are interested, I’d encourage a little brain work before taking action. Financial decision-making, similar to grocery shopping, is a personal decision. For some people, Series I bonds may serve as the fresh fruits and veggies of your diet. For others, they may be more like the fourteenth loaf of bread that goes into the freezer joining an unpalatable lump of ice-encrusted carbohydrates. This blog post is intended to give you some food for thought into the investment opportunity of Series I bonds.
If you just want to jump into going it, scroll down to the bottom of this post for two links that walk through the purchasing, step-by-step.
What is a bond?
First of all, a bond is essentially a loan where you, as the investor, are the lender. You loan your money to some entity, and the entity pays you some rate of return. Similar to a loan, a bond has a coupon payment (the interest rate), and a “term” stating how long the bond will exist. Key details for the Series I bonds:
- The entity you are loaning your money to is the United States government.
- The following groups of people are eligible to purchase Series I bonds: US citizens, residents in the US, or civilian employees of the US.
- The interest rate for the Series I bond is composed of two parts – (i) a fixed rate and (ii) an inflation rate. The fixed rate is just that, fixed (like a fixed mortgage interest rate). The inflation rate is a variable rate that can, and usually does, change every 6 months. As of May 2022, the Series I bond rates are: 0% fixed and +9.62% (annual) inflation rate
- The term of the loan is stated to be 30 years, but you can get your money back by redeeming the bond anytime after 1 year. So, the effective term is more like 1 year +.
- The maximum allowable contribution per person is $10,000/year (for electronically-held bonds). Paper bonds have a limit of $5,000.
How do the interest payments work?
You are paid the interest owed to you when you sell the bond. A key detail is that the interest payments accumulate silently, and are credited to your investment only when you redeem the bond. For example, suppose you bought a $1,000 bond in July of 2022, and sold it five years later. Here would be the financial timeline:
- In July of 2022 you send $1,000 to TreasuryDirect.gov (the online portal where you can buy US government bonds).
- Between July 2022 and July 2027 every time you login to your account (IF you remember how to login to your account – see below) you see a balance of $1,000. That is not very exciting.
- In July 2027, you redeem the bond. You would be paid back the $1,000 + all accumulated interest. If the inflation remained high and the rate stayed at +9.62%, then you would receive $1,599. But even if the rate started at +9.62%, but dropped back to a more typical inflation rate of +2% by 2024, then in 2027 you would receive $1,209 (See endnote (1) if you want the math details). Either of those scenarios beats cash held in a savings account!
What if the interest rate changes?
The fixed rate will not change. It will be the same based on the date of issue (0% in May 2022). However, the inflation interest rate (currently 9.62%) certainly will change. Every six months, the rate is changed to match the wider rate of inflation, endnote (2) lists the actual criteria. But, it is promised that the rate of return will not be below zero! For a table of historical inflation interest rates, see endnote (3).
How does the term work?
Series I bonds are established as 30-year bonds, with minimum and maximum holding periods. The minimum holding period is 12 months. If you sell the bond before 5 years are up, you forego the last 3 months’ worth of interest. That is still better than a sharp stick in the eye.
Is your money safe?
Series I bonds are backed by the full “faith and credit” of the United States Government. A loan to the US government is like the polar opposite of loaning money to your deadbeat cousin who has a great idea for starting a new crypto currency called “Brah coin.” The US government is about as credit-worthy of a borrower as exists in our world. As long as you believe that the US will continue to exist and pay on its promises, you will get paid back. That is about as low of a risk as exists in the financial world.
What are the tax implications?
The interest you receive on the bonds is taxable in the year that you redeem the bond. However, if the proceeds are used to pay for higher education expenses, the interest may be tax-free! Hmmmmm, remember that food-for-thought note I made? For more information about the tax benefits or using Series I bonds to pay for education, you can go to, https://www.treasurydirect.gov/indiv/planning/plan_education.htm
Who should consider Series I bonds for their portfolio?
I think everyone might consider Series I bonds if you are saving for the future, or as my friend Dave calls, “hooking up a future brother.” However, I want to re-frame the question. A better question than “who?” is “for what purpose?” I think Series I bonds could be an excellent investment for a goal that is needed in the next 1-5 years. These are goals that I call “intermediate-term goals.” The Series I will protect the purchasing power of your investment against inflation (by providing a return equal to inflation), AND the bond carries nearly zero risk of loss. No equivalent statement could be made about an investment in the stock market.
Longer time-frame investments
If your money has a longer time-horizon than 5 years, then it is a reasonable expectation that stocks will provide a higher-long term rate of return than Series I bonds. Historically at least, this has been true. Stocks have returned an average annual return of between 8-10% over the long-term. In contrast, series I bonds have historically returned roughly the same rate as inflation (which has been 2-3% over the last 20 years). In even a long-term investment portfolio however, many people want a mix of riskier (stock) investments and safer (bond) investments. Thus, Series I bonds may be a good candidate for the safer money, and could still deserve a plate on your investment table.
How to purchase Series I bonds
You have to directly buy Series I bonds from the US Treasury. Your investment advisor or broker cannot buy Series I bonds on your behalf. If you are comfortable with electronic banking, you can set up an account with Treasurydirect.gov (note the spelling in the URL and the .gov suffix – make sure you are on the legitimate US Treasury site!). If you want the paper format, you have to buy the Series I bonds from your tax return??!! (I have zero experience with this last point, so I am only parroting what I read on the Treasury Direct site).
Who (or what purpose) would NOT be a good candidates for Series I bond investment
The usual. You should not invest money if that money is needed within the next year. You probably should not invest if you do not have a good emergency fund built up. You probably should not invest if you have any high interest credit card debt. Undoubtedly, there are other situations that I am not thinking of.
My personal experience and pitfalls
I recently shifted the monthly contributions into my kids’ college funds to Series I bonds (from our 529 college savings accounts). My rationale is that the time-frame for the goals (for our family) is now in the intermediate time-zone, and the current age-based investment strategy within the 529 accounts invests in a lower returning investment than the Series I bonds are offering.
It took me 15 minutes to set up the TreasuryDirect account, to connect my bank, and to fund the purchase. WOW, 15 minutes to do all that on a federal government website? I was impressed. The font and look of the website had the look and feel of an old Happy Days re-run, but it worked!
The only problem I ran into was when I tried to re-login to my account. The login screen did not ask for my username or password (which I had saved). It asked for my account number. I could not find the email that told me my account numbers. So, here is what I did:
- I tried to re-request my account number through clicking on a link that says “Can’t find your account number?” That link took me to a form that would send me my account number after I entered some information. The information-gathering form was a repeat copy of my original application, asking for ALL information that I originally submitted. It took me another 15 minutes to complete. Once I submitted it, I was informed that I had “something was wrong with my submission” but there was no guidance as to what that something was. Infuriating.
- I sent a secure message into their “help center” with a request that they send the account number to me on my physical address on record. I received a nice email reply that said something like, “At this time we are not responding to email inquiries. Please call our service center.” INFURIATING!
- I called and waited on hold for two hours. The person I spoke to helped me recover my account number (verifying my identity). I asked her to stick with me while I made sure that I could log in (because I had just waited on hold for two hours and I wanted to be sure it worked). She tersely, and rudely, responded with, “you’d better be quick about it.” FRUSTRATING, but she was helping me, so I held back my tongue.
All that to say, given my experience with ancient fonts, poorly crafted help forms, a rude government bureaucrat, but an excellent product that only those affiliated with the US government are allowed to purchase, I am quite confident that my investment is truly with the bonafide United States Government. Long live America! I remain an indebted, grateful, though snarky, citizen of the United States.
If you are wondering whether Series I bonds would fit within your financial planning, please contact your advisor directly.
–End Notes —
(1) Math details in the projected return. I assumed that the inflation rate would drop by -2% each period (every six months) until reaching a floor of +2%, and it would remain at 2% thereafter.
(2) According to Treasurydirect.gov, the inflation rate is based on changes in the nonseasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy (CPI-U for March compared with the CPI-U for September of the same year, and then CPI-U for September compared with the CPI-U for March of the following year).
(3) Table of historical inflate interest rates from Treasury Direct: https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm
Guides to setting up a Treasury Direct Account and purchasing Series I bonds
- A one-page guide written by John Chesbrough, CFP(R) (the author of this post): “Set up an account with Treasury Direct – tips and suggestions“
- Web article: You’ve Got a Month Left to Get a 9.62% Rate on I Bonds: How to Buy Them
