Series I Bonds – A Positive Development From the Inflation Spike

February 1st, 2022 by Jim Allen

Last month we wrote an article about the current inflation spike and the pain it is inflicting on your monthly spending. The higher cost of living can be attributed to a combination of supply chain issues causing demand to exceed supply for goods, and a shortage of workers due to COVID and demographic trends.

Inflation can have a negative impact on your standard of living if your expenses are rising faster than your income (wages and investments). In the current historically low interest rate environment, this is exactly what is happening as interest earned on bonds, CDs and bank accounts have not adjusted to higher inflation. While increases in interest rates is one of the primary ways the Federal Reserve combats inflation, there is generally a lag which leads to something like the current situation where inflation is high but interest rates have remained low. We expect the Federal Reserve to begin raising interest rates this year which will start to eliminate the current imbalance.

While you are currently paying 6+% or more in higher prices and your CDs or bonds are still paying well below 1%, there is an investment that has benefitted from the current inflation spike. That investment is a blast from our past – US Savings Bonds. Now, the Savings Bond we are talking about is a much more modern version of the old EE bonds we used to buy in school or were given as gifts by relatives. Series EE Bonds still exist, but they are just not attractive in the current interest rate environment. The bonds we are talking about here are Series I Savings Bonds.

What makes Series I Savings Bonds attractive right now is the interest paid has an inflation index component to it. Series I Bonds have a fixed interest rate (which is currently zero) but then is also tied to the Consumer Price Index, which currently has spiked along with inflation. In fact, the current semi-annual inflation rate for Series I Bonds is 3.56% which translate to an annual interest rate of 7.12%! An interest rate at this level with virtually no risk is an extremely attractive investment. For example, if you own $10,000 of Series I Bonds, your annual interest would be $712. To compare, one-year CDs currently pay about .50% or a mere $50 in interest.

Not only is the current interest rate superior to virtually every other fixed income option, the bonds have other benefits:

  • Series I Bonds are guaranteed by the US Government, so there is virtually no default risk.
  • Series I Bonds do not go down in value as interest rates rise like other types of long-term bonds.
  • Series I Bonds are state income tax free.

So why isn’t everyone flocking to Series I Bonds? There are some catches you need to be aware of:

  • The maximum amount of Series I Bonds you can purchase in one year is $10,000 per individual. If you have an income tax refund, you can purchase up to a maximum of another $5,000 with that refund. This means that the ability to invest in these bonds are limited.
  • You must hold the bonds for at least 12 months before redeeming.
  • If you redeem during the first 5 years, you will lose 3 months interest payments. In this manner the Series I Bond is very much like a 5-year CD.
  • The interest rate does reset every 6 months so there will be fluctuations in the rate paid.
  • You cannot sell them on the open market – they are only redeemed by the US Treasury.
  • You need to buy them directly from the US Treasury through their website TreasuryDirect.gov.

The drawbacks of Series I Bonds are relatively minor when compared to the interest rate return vs. other cash assets like money markets, CDs and savings accounts. If you have idle assets that are earmarked for goals that are more than 12 months out, Series I Bonds currently have a very compelling value proposition. The recent interest rate spike makes these very attractive and the short-term trend is positive for rates on Series I Bonds for the immediate future.

If you would like to discuss if these are appropriate for your portfolio and financial plan, please don’t hesitate to contact us for a consultation.

Jim Allen, CFP, ChFC, EA, CDFA is President and Chief Financial Planner at Anchor Bay Capital. In addition to his 35+ years of financial planning experience and his professional credentials, he holds a master’s degree in Financial Planning and is a former instructor in the CFP program at the University of California Irvine. He is also the co-author of the book “The Tools & Techniques of Charitable Planning.” Jim can be reached at [email protected]