Series I Bonds – The #1 Way to Fight Inflation

Are Series I Bonds worth investing in? Retail investors have dealt with a challenging beginning to their year. Additionally, the economy is dealing with the highest inflation rate in four decades.

Investors have become more entitled to high growth returns, dropping the desire to invest in bonds in their investment portfolio. Many will slowly miss the benefit of using their money to add incremental gains. 

Series I Bonds are doing just that. 

Currently offering a 9.62% annual rate on investment and fully backed by the United States Treasury. This Treasury security is used by many investors to combat inflation. They also offer a much higher rate of return than your average savings bonds rates. 

What are Series I Bonds?

“I” Bonds are taxable, variable-rate, low-risk products that help protect your savings from inflation. It is backed by the full faith and credit of the United States Government.

These bonds accrue interest based on combining a fixed interest rate and semiannual inflation rate. Currently, it is offering a 9.62% interest rate. However, this is subject to change every 6 months. 

Series I Bonds can be compared to Treasury Inflation Protected Securities (aka TIPS), but they have some distinct differences. I Bonds can not be purchased on the secondary market, thus they are not marketable or traded. This means that if you buy the bond for $5000 today, the bond value will still be worth $5000, not including interest until it is redeemed. This would be considered to retain its face value until the maturity date or once it is redeemed.

So, the bonds do not have interest rate risk that directly affects the price.

Both TIPS and I Bonds are inflation-indexed securities. Meaning the interest they pay goes up or down based on CPI changes. I Bonds specifically change their interest rates every six months in May and November. More on this later.

From a tax perspective, Series I bonds are taxed by federal income taxes, but not state or local taxes.  

What Causes the Interest Rate to Change?

Two factors determine the Series I bonds’ interest rate.

The first segment is the fixed rate. This is an agreed-upon rate that the Treasury offers. When an I Bond is purchased, the fixed rate will remain the same throughout the life of the bond, until maturity. Currently, the fixed rate is 0.0%. Not great. 

The second segment is the variable semiannual inflation rate. This rate is found by multiplying the semiannual inflation rate by 2. Currently, this rate is 9.62%. A much more attractive level for risk-off investors.

The combination of the two rates gives us the composite rate of return. 

So, in order to get the full interest rate of the I Bond, you add the fixed-rate and annualized inflation rate. This rate is defined by the urban consumer CPI, also noted as the CPI-U

How are Series I Bonds Purchased?

I bonds can be purchased in one of two ways. They can be purchased the old-fashioned by mail when filing your federal tax return. Or they can be purchased electronically through Treasury Direct, offered by the Treasury Department. 

TreasuryDirect is the online portal that allows investors to buy, hold, and redeem Treasury securities online. The maximum yearly allocation for Series I Bonds is $10,000 and the minimum amount you can purchase is $25. 

To some, a $10,000 allocation may not seem like

much. But it is a big deal for the average retail investor to be able to invest in a low-risk bond that currently pays interest in the high single digits. 

How Long Can I Hold an I Bond?

I bonds can earn interest for 30 years total unless they are cashed out first. There are a few limitations of I bonds that investors should understand. 

These bonds must be held for at least one year at a minimum. If an I bond is redeemed within five years of purchase, then the investor will take a penalty and lose three months’ worth of interest. So, if you redeem an I bond after 26 months, you would receive 23 months of interest. 

The Case for Purchasing an I Bond

With a current interest rate that yields 9.62%, investors have come flocking to the window for the chance to combat inflation. But, is it too good to be true? Perhaps, maybe for once, it isn’t. 

With this rate locked in through October, the next composite rate will be announced in November 2022. It will be based on the change in the semiannual consumer price index inflation rate from September 2021 to March 2022 and March 2022 to September 2022. 

Needless to say, we have seen the month-over-month CPI show positive prints over the last two years. This would show that barring any large setback in inflation over the next 3 months, we would expect the next I bond interest rate to be even higher.

Eventually, inflation must come down, and so too will the I bond interest rate. At some point, investors should even be wary of deflation. For now, we expect inflation rates to remain stubbornly high. Allowing this savings bond to have a similar bond yield compared to a high yield investment. 

From a macro perspective, many have felt the pain of rising costs in America. Inflation has taken its grasp on energy, food, and rent. Series I bonds are offering an easy way for the average American to directly fight inflation that can eat away from cash sitting under the mattress.

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Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including a detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.