It’s Not Too Late to Get on the I-Bond Train

It seems like everyone in the personal finance space is talking about I-bonds lately… and for good reason. Inflation is soaring and I-bonds are currently paying interest at an APR of 7.12%! Plus, that interest rate is projected to increase to 9.6%+ in May 2022!

I-bonds are a type of government savings bond that pays an inflation-adjusted interest rate.

As inflation rates have continued to climb in recent months, so has investors’ interest in this type of savings bond. March inflation numbers from earlier this week hit a 40-year high of 8.5%!

We purchased the maximum amount of I-bonds back in December 2021, and then again in January 2022.

Several bloggers beat me to publishing articles on this topic back then. Because of that, I never finished the blog post I’d intended to write, professing my excitement for this investment. However, as interest continues to grow and I see more people asking questions on the topic, I’ve decided to share my 2-cents on the topic anyways.

To be clear, I think I-bonds (as a part of a diversified portfolio) are a great inflation hedge. But that’s not the only reason I’m a fan. I also like them for the benefits they offer as an emergency fund and cash supplement. I’ll talk more about this below.

If you’re still sitting on the sidelines, wondering if you’re too late to get on board the I-bond train. The answer is no!

Disclaimer: I’m not an investment professional. The content within this post represents my opinions and is not advice.

What are I-Bonds, and why are they so great?

As mentioned above, Series I-Bonds are a type of U.S. government savings bond that pays interest at rates adjusted for inflation every six months.

You purchase I-bonds at their face value. The government guarantees that they will never decline in value, so they are (nearly) risk-free. The bonds have both a fixed and variable interest component, which accrue monthly and compound every six months. The government updates these fixed and variable rates in November and May each year.

Earning interest

The stated fixed rate at the time you purchase your bonds is the rate you’ll receive as long as you own your bonds. When these rates updated every six-months, the new rates only apply to new bond purchases. The fixed rate is somewhat arbitrarily determined by the government, and has hovered at or around 0.0% in recent years.

The variable rate on your bonds; however, will update every six months while you own them. These rates are directly tied to inflation.

Because inflation is currently sky-high, so are I-bond yields. This is the main reason why everyone is raving about them. For I-bonds issued between November 2021 and April 2022, you’ll earn interest for six months at an effective annual rate of 7.12%!

With the recent inflation numbers climbing even higher, experts are projecting that May rates will top 9.6%! That’s pretty darn good for a return that is (nearly) risk-free!

How do you buy I-bonds?

You can purchased I-bonds electronically in any denomination above $25. The maximum amount you can purchase in a calendar year is capped at $10,000 per person. You can also apply up to $5,000 of your tax refund towards paper bonds, if you so choose.

Although they can’t be purchased through your normal brokerage account, I-bonds can easily be bought fee-free from Treasury Direct. You’ll find more detailed instructions on how to purchase these bonds and frequently asked questions on the website as well.

So, what’s the catch?

Other than the low purchase limits, the biggest downside to I-bonds is that you can’t redeem them in the first 12 months. After that, you can cash them in whenever you’d like. However, if you redeem them before five years, you’ll lose three months of interest.

As far as risk, these bonds seem about as safe as investments can get. They are currently paying a hell of a lot more than most low-risk investments or high-yield savings accounts – ours is currently 0.5%. Unless the government defaults, (in which case, we’ve got bigger problems), your principal will never fall below zero.

Additionally, if we enter a period of deflation, the total rate for a six-month period cannot go below zero. Said another way, you shouldn’t lose any principal or previously accrued interest.

That said, for long term growth, the stock market will generally be a better investment for beating inflation. But if you expect to need your money within the next 1 – 3 years, the stock market is not the safest place to park it.

If inflation rates subside and/or the stock market stabilizes, returns on these bonds will become less and less attractive compared to other investment options. But that’s ok. The way I see it, you can lock in high returns for at least the next year by purchasing now. And if rates fall, the loss of three-months of interest won’t matter as much. You can then just cash them in and move the money elsewhere.

It’s not too late!

If you’ve got some extra cash that you might want to use within the next few years, it’s not too late to get the benefit of I-bonds and protect that money from inflation!

An I-bond purchased in April 2022 will receive interest for six-months equivalent to an annual rate of 7.12%. Then, beginning in October, you’ll receive six months of interest at the soon-to-be announced rates, which are expected to be above 9%. We should know the actual rates on May 2nd.

IF you wait until May, you’ll miss out on the 7.12% rates. You’ll still receive the ~9% interest rate (or whatever the final May rate is) for six-months, before your rates update. Assuming the government is able to get inflation under control, this option is less desirable than buying in April. However, it may take a while for inflation rates to return to normal, so may still be attractive to you.

Given the current demand for these bonds, I don’t expect the government will increase the fixed rates above zero percent.

Why I’m a big fan of Series I-bonds…

There’s three main reasons why I’m loving I-bonds right now. Although they aren’t right for everyone, here’s how we’re using them in our portfolio.

(1) Inflation protection

Ok, so this one’s sorta obvious. Since the variable component of I-bond rates is directly tied to inflation, returns should keep up with or beat inflation.

I want to reiterate again that this is not the best investment to beat inflation over the long term. Investing in the total stock market is a better way to maximize your returns (for a reasonable level of risk). However, as we’ve seen so far in 2022, the stock market doesn’t always beat inflation. Nor does it always go up.

If you’re dealing with a short time period, and want to avoid your money going down in value, I-bonds can be a great way to hedge against inflation, while knowing your money will be there when you need it.

(2) Emergency fund supplement

If you’re still working on building your emergency fund, have a very small one, or think you’ll need your money within one year… I-bonds may not be right for you.

However, we tend to keep 6 – 12 months of expenses in cash. I’m pretty risk adverse, so I’ve always had trouble getting comfortable below this amount. This money helps me sleep at night, and also gives us the financial flexibility to take advantage of good investment opportunities when they arise (i.e. the pandemic market crash of March 2020).

Now that we’ve got two tranches of I-bonds, I’m finally comfortable significantly lowering the amount of cash we hold. If something happens where we need cash beyond our smaller emergency fund, we can just cash out our I-bonds to pay the bills.

You can’t redeem an I-bond in the first year, but anytime after that is fair game. I don’t need to worry about the money not being there when I need it, since the U.S. government guarantees the bonds’ value. Whereas, if I were to invest that money in the stock market, I might need to sell it at a loss (since we usually can’t control when “emergencies” happen).

(3) Early retirement funding

Using I-bonds to fund our early retirement isn’t something I had thought about until a few months ago… perhaps because they weren’t an attractive investment before inflation went crazy.

However, the perfect storm of high inflation and a falling stock market could wreak havoc on even the best laid early retirement plan.

Sequence of returns risk is one of the biggest risks facing early retirees. Because we plan to fully retire within the next few years, it might be advantageous for us to continue buying $20,000 in I-bonds each year to use as a hedge against both inflation and down markets in our early years.

If we did this, we could create an I-bond ladder. We could then use I-bonds to cover some or all of our expenses in the event of a down market during our early years of retirement. If the market is booming we could just sell shares, but if it’s down, we could avoid eroding too much of our principal balance by selling I-bonds instead.

This is similar to the cash bucket strategy, but provides for better protection against inflation. We’ll still keep a good portion in cash, but current high-yield savings rates aren’t very attractive.

If you’re not planning for early retirement, this strategy could be useful for earning more on a down payment for your future house or saving for a child’s education. We’re strongly considering buying $10,000 this month in our child’s name as a supplement to her 529 Plan.

Have you gotten on the I-bond train yet?

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