- U.S. Treasury Series I bonds pay an adjustable rate based on changes in the Consumer Price Index.
- The bonds, which adjust rates semiannually, will begin paying a 9.6% yield to investors in May.
- I bonds come with tricky rules, such as one requiring investors to hold them for at least a year before redeeming them.
Whether they're on the brink of retirement or just starting out in markets, investors across the country are asking themselves the same thing: How can I keep up with inflation? With the last reading from the Consumer Price Index — a tool used to track the change in price among a basket of consumer goods — showing an 8.5% annual increase in March, it's a become a rather big ask.
Or has it? Consider U.S. Treasury Series-I bonds, or simply "I bonds." These inflation-adjusted U.S. savings bonds pay a fixed interested rate throughout the life of the bond plus an inflation rate pegged to changes in the CPI that's adjusted each May and November.
Currently, I bonds pay 7.12%, a figure that's expected to rise to 9.6% beginning in May.
Investors are taking notice. They've bought $11 billion worth of I bonds over the past six months compared with $1.2 billion in purchases over the same period a year ago.
And if using short-to-medium-term money to keep up with inflation is the goal, they're probably onto something, says Eric Jacobson, a fixed income strategist for Morningstar. "The first place to start is with I bonds," he says. "They don't come with price volatility and you know exactly what you're getting if you turn them in early or hold onto them for longer."
But before you start running your money down to the Treasury to purchase these bonds, make sure you understand the rules surrounding buying, selling, and owning them, experts say. Below, they detail why, or why not, I bonds might be right for you.
Generally speaking, the more attractive the potential return an investment offers, the greater the risk the investor must take on to realize it. During periods of rising inflation, I bonds turn this notion on its head.
The 9.6% interest rate investors will earn starting in May trounces the 2.6% yield offered by index funds tracking the broad bond market and is almost laughably high compared with the 0.6% you'll earn, on average, if you stash your cash in a bank account, according to Bankrate.
Typically, when it comes to bonds, higher-paying debt is issued by companies or governments with low credit ratings, meaning the debt carries a higher risk of default. But this isn't the case with I bonds, which are issued by the U.S. government, an entity that has never defaulted on its debt.
Video by Courtney Stith
"Thanks to the upward trajectory of CPI, I bonds have become a top-yielding U.S. asset, even though they carry virtually no risk of principal loss," says Natalie Colley, a certified financial planner with Francis Financial in New York City.
Because you buy these bonds directly from the Treasury (more on that in a second) and they, unlike other bonds, cannot be bought or sold on the secondary market, they can't gain or lose value based on market demand. "You are guaranteed to, at a minimum, get your principal back," says Thomas Blackburn, a CFP with Mason & Associates in Newport News, Virginia.
Interest rates on I bonds readjust every six months and compound semiannually, but you won't see any of that money until you cash out. And the rules when it comes to cashing out can get tricky. For one thing, these bonds can't be redeemed for at least 12 months from your purchase date.
That means any money you plan on using in the next year doesn't belong in this investment.
You'll face a penalty equal to three months' worth of interest if you cash out any time over the first five years of owning the bond. "That's not a deal-breaker at these rates, but something to be aware of," says Matt Stephens, a CFP with AdvicePoint in Wilmington, North Carolina.
Whenever you decide to cash out, you'll be on the hook for federal taxes on the interest you earned, though you may be exempt from tax if you use the proceeds to fund qualifying higher-education expenses. I bond interest is not taxed at the state or local level.
Video by David Fang
I-bonds must be purchased online, and you can buy no more than $10,000 worth per person per calendar year. You can purchase an additional $5,000 in I bonds using money from your tax refund if you file Form 8888, but it's too late to do so this year.
If the limits won't cause you much hassle when it comes to buying one of these bonds, the purchasing process very well might, says Stephens. "You have to buy it directly from TreasuryDirect, and it's a huge hassle to open the account and navigate the website," he says. "Imagine if the DMV had an online store — that's what this experience is like."
If you're aware of the tax rules and willing to navigate a tricky website, I bonds offer an attractive option for investors with a stash of cash they're hoping can keep up with inflation, financial experts say. But remember: The 9.6% interest rate that these bonds will pay in May won't last forever.
"The rate of interest changes at the six-month mark, and will likely fall again once the CPI rate goes down," says Colley. "So, the higher interest rates will only be available while the rate of inflation stays high."
Instead of counting on these bonds for the long term, you can use them to juice up the income you're earning on a portion of money you currently have sitting in cash and earning practically nothing, experts suggest.
Video by Stephen Parkhurst
"We see these bonds as a pretty good deal, even if you decide to liquidate earlier than five years," says Colley. "Even after being penalized, the interest is pretty good compared to what a CD or savings account will provide. We think I bonds are an ideal alternative for a portion of an emergency fund."
Blackburn agrees, and has been moving tranches of cash his clients won't use within a year into I bonds. The goal over the next few years is to "have the majority of their emergency fund in I bonds and eventually completely liquid," he says.
And if inflation subsides and I bonds become less attractive than other types of low-risk investment vehicles? "We just surrender them and relocate them somewhere else."
The views expressed are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.
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