Britannica money (2024)

WhenInflation is rearing its ugly head, it is difficult to find anything – stocks, bonds,even 'junk' bonds-with a dividend that keeps pace with the increaseconsumer prices. An investment that doesSeries I Savings Bonds, also known as I-bonds, offered by the U.S. Treasury Department. The yield on I-bonds is adjusted every six months to reflect the rate of inflation, and in mid-2022 that rate rose to a multi-decade high of 9.62%.

The eye-popping dividend sent millions of investors scramblingTreasuryDirect.govto open an account and watch the interest payments roll in. But when inflation started to decline, the Treasury Department lowered interest rates. As of November 2023, I bonds will still pay 5.27%.

There's a lot to like about my tires, especially during periods ofhigh inflation. But they are not the ultimate investment solution and they are not necessarily suitable for everyone. In fact, like any investment, they come with some risks.

I-bonds are inflation-protected instruments offered by the Treasury Department and are designed to protect investors from rising prices. Why was the yield so high?

• I-bonds are continuously adjusted for inflation.
• The rate is calculated twice a year and is based on changes in the non-seasonally adjusted rateThe consumer price indexfor all urban consumers (CPI-U) for all goods, including food and energy.
• When inflation goes haywire, as it will in 2022, I-bond yields rise, making it a more powerful investment tool.

The main reason why many investors suddenly became interested in I-bonds was rising US inflation, which pushed I-bond yields above 9%. But remember that the interest rate on I-bonds resets every six months based on the CPI-U. The current rate, good for purchases between November 1, 2023 and April 30, 2024, is 5.27%. If inflation slows, initial I-bond yields could fall even further.

That said, yields on comparable government bonds at the time of the interest rate adjustment were in the upper 4% range.

Takeaway for investors? The initial return is only good for the first six months you own the bond. After that, the investment works like any other variable vehicle, meaning interest rates can fall and are out of your control. And if you wait until e.g. By purchasing an I-bond, the initial interest rate in 2025 can be well below current levels.

Variable interest rates are a risk you can't discount when you buy an I-bond, and it's not like you can just sell the bond if the price falls. You're stuck for the first year and can't sell at all. Even after that, a penalty of three months' interest applies if you sell within five years. So if you think you'll need some of the money before then, I bonds may not be for you.

It may sound a bit disappointing, but there are also a lot of good things about I bonds.

I connect professionals

• Competitive interest rate.At least for now.
• Low risk.They are backed by the US Treasury Department, which has never defaulted on its debt payments. This means that you will almost certainly pay your interest on time and get your principal back at the end of your ownership.
• Portfolio diversification.Mostfinancial advisorsdo you recommend that?balance your portfoliobetween riskier, more aggressive investments such as shares and less risky investments such as government bonds.
• Inflation hedge.The interest on the bond will grow at about the same rate as inflation, meaning your savings won't lose their purchasing power.

I link disadvantages

• Variable interest rate.The original rate is only guaranteed for the first six months of ownership. After this, the rate can decrease to a fixed rate part, which amounted to 1.3% as of November 1, 2023.
• One year lock-in.You won't be able to get your money back at all in the first year, so you shouldn't invest money that you absolutely need right now.
• Punishment for early withdrawal.If you cancel after one year but before five years, you sacrifice the last three months' interest.
• Victims' costs.Having too much of your portfolio in government bonds could mean missing out on big gains in the stock market. Between 2015 and 2019, the total return on I bonds never exceeded 2% per year. In the meantimeS&P500had several years of double-digit annual profits.
• Annual investment limit.The maximum amount you can invest in an I bond is $10,000 per share. person per year. If you and your partner both invest €10,000, that is your maximum until a year later.
• Interest is taxable.The interest on I bonds is subject toFederal income tax, which depends on your income. For many investors, the federal income tax rate is higher thancapital gains taxsit.
• Not allowed on tax-deferred accounts.Because I bonds are limited to taxable accounts, you cannot purchase them in an Individual Retirement Account (IRA) or401(k)-plan. And if you're saving for your children's college education, you can't put them directly into a 529 plan. But if you buy I bonds under your child's CPR number, their interest will be taxable at their rate, which is usually quite low: zero if they earn no more than the lowest marginal tax rate.

I bind investment strategies - for better or for worse

For many people, the annual maximum investment limit of $10,000 is not a problem; that's a lot of money to have on hand after all your expenses have been paid and your tax-advantaged retirement savings has been funded for the year. If you are fortunate enough to have more than $10,000 ready to invest, you will need to look for other investments if yourisk-adjusted returnmaybe not so attractive.

That's why I-bonds are a good treatment for many investors, but not a panacea against inflation.

The good thing about bonds is thatautomatically pension. Every six months, the interest you earn is added to the principal, so you earn interest on an ever-growing pile the longer you keep your money invested. The bond bears interest for 30 years or until you pay it off, whichever comes first.

The variable interest rate is another risk to take into account. While most Americans would probably be pretty happy if inflation dropped from a 40-year high to 2010-2020 levels (about 2%), it would be a pretty big disappointment for your I-bond investment. The rate you bought it for is only guaranteed for the first six months. There is nothing stopping the country from moving to 2% or even its fixed guarantee component of 1.3% at some point. But remember: you are only required to hold the I-bond for one year. Then you can sell it (remember, you'll get three months' interest if you pay it out between years one and five).

Also, don't invest too much in an I-bond if it will deplete your savings. Save yoursemergency fundfully intact before diving into an investment with a lock-up period. For example, suppose you have $5,000 and invest it in an I-bond, but two months later lose your job. The $5,000 cannot be withdrawn for the next ten months.

In short

I-bonds are a convenient and relatively safe investment that offers some protection against runaway inflation. But they aren't the answer to all your inflation problems, and there are risks associated with tying up your money in an investment with withdrawal restrictions. Keep the risks and benefits in mind before you buy.

References

• With bonds| treasurydirect.gov