With interest rates so low today, investors wonder where they can keep their money safe both in terms of their principal and purchasing power. We recently discussed Fixed Annuities as one substitute for CDs or bonds, with the conclusion that Annuities are best for investors over 59 1/2 who don’t need liquidity for at least five years. For others, one often overlooked option is Inflation-linked Savings bonds, officially known as Series I Bonds.
I-Bonds are related to the familiar EE savings bonds that so many of us have held in the past. Instead of paying a fixed rate of return, the yield on I-Bonds consists of two parts: a fixed rate that is set for the life of the bond and an inflation rate which changes every six months, based on the Consumer Price Index for Urban Consumers, or CPI-U.
The current run of I-Bonds is yielding 1.64%, which includes a fixed rate of 0.10% and inflation of 1.54%. That rate will change each May and November to reflect the most recent inflation measure. Although the Fixed Rate of 0.10% is not very appealing, at least you are guaranteed to keep up with inflation. In the rare event of deflation, your return cannot go below zero.
The Treasury Department no longer issues paper Savings Bonds, so the only way to purchase and hold them is through their website, treasurydirect.gov. I-Bonds are non-transferable and investors may purchase $25 to a maximum of $10,000 per year.
The bonds are 30-years in duration, but you can redeem the bonds anytime after 12 months. If you sell in the first five years, however, you are penalized the last three months of interest.
I-Bonds are Savings Bonds and should not be confused with TIPS or Treasury Inflation Protected Securities, which are Treasury Bonds. There are a number of differences between the two bond types. (Here is a good comparison chart.) The yield on TIPS is higher, but unless you hold to maturity, there is no guarantee that the market price (if you sell a bond) will exceed your purchase price.
In some ways, I-Bonds are an ideal fixed income vehicle. They preserve your purchasing power regardless of the level of inflation that occurs, and are uncorrelated to equity markets and interest rates. Inflation is a big risk for conservative investors; it’s the reason so many financial advisors refer to CDs as “Certificates of Depreciation”.
I’m not as enthusiastic about today’s fixed return of 0.10%. I feel like I can do better than a real return of 0.10%, even though it won’t come with the guarantee and backing of the US Treasury Department. However, if the fixed rate on I-Bonds were 2 or 3%, like they were when launched in 1998, I would gladly buy my $10,000 limit each year and count it as part of my allocation to bonds.
If you do have cash earning zero percent today, and have ruled out investing that money, Series I Bonds may be a safe way to keep up with inflation and protect your principal. If you are thinking of investing your emergency funds in I-bonds, invest half now and half in 12 months, so you can maintain some liquidity.
