I Bonds set to offer historic 9.62% interest rate
Which will offer higher returns over the next 12 months, I bonds or bitcoin? A year ago, such a question would have been silly. Today, not so much. Bitcoin
Here’s what you need to know.
I Bond Basics
First introduced in 1998, I bonds are issued by the US government. Investors buy I bonds directly from the government through the TreasuryDirect.gov website. Unlike most other US bonds, however, I bonds are designed to protect savers from the ravages of inflation.
To do this, they adjust the interest rate twice a year (May and November) according to the evolution of the CPI. Two factors determine the interest rate on an I bond: a fixed rate and an inflation rate. The combination of these two rates gives us what is called the composite rate.
Today, the fixed rate is 0%. Not very exciting and likely to stay at zero percent when the Treasury announces new rates in May. The inflation rate, however, will rise to 9.62% annualized based on the latest CPI figures released earlier this month.
Beyond the interest rate, here are some key characteristics of I bonds that you should know:
- There is a limit of $10,000 per person on the amount one can invest in I bonds each year
- Individuals can buy an additional $5,000 in I bonds with their tax refunds
- Trusts and corporations can also buy I bonds
- I bonds cannot be redeemed for 12 months
- Redeeming I bonds before five years will incur a penalty equal to 3 months interest
- Bonds must be bought and sold directly with the government. Therefore, you won’t find them in a mutual fund or ETF.
Buy bonds I in April
The current composite rate on I bonds is 7.12%. This lower rate has some wondering if they should wait until next month to buy I bonds. The answer is a resounding no. Here’s why.
The Treasury announces bond rates in May and November. When the new rates apply to a specific I Bond, however, depends on when you buy them. The key thing to remember is that you will never miss existing or new fares.
If you buy now in April 2022, you will benefit from the current composite rate of 7.12% for six full months. This is true even though the Treasury will announce the new rate in about two weeks.
More importantly, you won’t miss the new fare. Once you have owned Bond I for six months, you then begin to receive the composite rate that will be announced in May (estimated at 9.62%). And you will also receive this rate for six full months. The result is a rate of 8.37% for the first year.
You can view a helpful chart showing when bond rates change based on purchase date here.
I Bonds vs. TIPS
I bonds and TIPS (Treasury Inflation Protected Securities) protect investors from inflation. They do this, however, in two very different ways.
As stated above, I bonds protect us from inflation by adjusting the interest rate paid on the bond based on changes in the CPI. In contrast, the interest rate on TIPS remains the same throughout the life of the bond. Instead, the government adjusts the face value of the bond based on the CPI. The fixed interest rate is then applied to the adjusted nominal value.
There is another important difference. Unlike I bonds, TIPS can be bought and sold on the secondary market. Accordingly, you can buy TIPS through mutual funds and ETFs. This way, TIPS are easier to buy, especially in large quantities.
I Bonds vs. CDs
Given current and future yields on I bonds, they are significantly better than even the best CD rates. This is true even if one plans to sell Bond I after one year and incur the 3 month interest penalty. The main difference is that with I bonds you cannot liquidate the first year and you are limited in the amount you can buy. With a CD, you can still withdraw your money, subject to an interest penalty.
Today, I bonds are arguably the best risk-adjusted investment one can make. Frankly, browsing the government website to buy I bonds is no walk in the park. But with rates expected to exceed 9%, it’s worth it.