Should You Invest in I Bonds for Inflation Protection? † Personal Finance

(Robin Hartill, CFP®)

In normal times, a guaranteed return of 9.62% on your money with virtually no risk would be impossible. But with inflation at its 40-year high, that’s exactly what Series I bonds offer. The US Treasury Department recently announced that from May to October 2022, I-bonds will pay an annual interest of 9.62% on bonds issued.

If you’re concerned about inflation and recent stock market volatility, you may be wondering if you should invest in I-bonds now. While I-bonds can be a great option for those looking for safe investments, there are a few things to know before buying.

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What are I-bonds?

I-bonds are a type of savings bonds that have recently come into fashion due to skyrocketing inflation. The bonds pay a fixed interest rate – currently 0% – that remains the same over the 30-year life of the bond. But the bonds also pay a variable inflation rate that adjusts every six months. The 9.62% annual interest that I bonds pay comes entirely from that variable inflation-adjusted interest rate.

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Savings bonds are backed by the full trust and credit of the federal government. Your risk of not getting back the money you invest in I bonds, plus interest, is as close to zero as possible.

The interest is compounded semi-annually and added to the principal of the bond. So if you buy $1,000 worth of I-bonds now, you’ll earn 4.81% (half of 9.62%). In October, the value of your I bonds would be $1,048.10.

But there are some caveats: When you invest in I-bonds, you can’t cash out for a year. If you pay off your bonds in the first five years, you also lose three months of interest. For example, if you paid out after 24 months, you would only receive 21 months of interest payments.

You also cannot purchase more than $10,000 worth of I-bonds electronically through TreasuryDirect.gov in any given calendar year. However, you can buy $5,000 worth of paper I-bonds using your tax refund.

Should I invest in I-bonds?

Investing in I-bonds makes sense for medium-term goals — think one to five years ahead — if you want to park your money in a way that keeps pace with inflation.

Let’s say you want to buy a house in two or three years. You would not want to invest your down payment money in stocks as the market can fluctuate significantly in the short term and you will need your money in a few years.

But even the best high-yield savings accounts currently offer interest rates well below 1%. When you keep your money in a savings account, inflation erodes year after year.

Investing in I-bonds makes sense in this scenario. You don’t need your money right away. Other investments offer the prospect of a higher return, but are also more risky. Because you want to make sure that the money you have saved is there when you need it, investing it in I-bonds is a good move.

Of course, that 9.62% rate is likely short-lived. The Federal Reserve continues to raise interest rates with the aim of cooling inflation. If inflation falls, I will also do bond yields. So if you choose to invest in I bonds, don’t expect to earn 9.62% year after year.

Who should not invest in I-bonds?

It is essential to build a six-month emergency fund to protect against unexpected loss of income or major expenses. But emergency savings must be liquid, which means you can have your money quickly and without penalty. Since you can’t cash out I-bonds for a year, they’re not a good option for your emergency fund.

Having long-term investments is just as important. That 9.62% rate could be particularly attractive in lieu of the stock market’s poor performance so far in 2022. Year-to-date, the S&P 500 index is down about 13%.

Investing in the stock market has a track record of beating inflation for a long time. The 9.62% interest that I bonds pay is an anomaly — the highest amount paid since the federal government introduced inflation-adjusted savings bonds in 1998. Meanwhile, a return of 10% is what you would expect from the stock market in an average year.

Taking advantage of the unprecedented returns on I-bonds could be a smart move if inflation soars. But I-bonds are not a substitute for short-term savings or long-term investments.

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