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Series I Bonds
Don’t know what these are? Good thing you’re reading this because I’m going to give an actual investment idea. When I’ve written in the past about safe trade ideas (long Exxon shares, short its debt), there was admittedly a somewhat impractical element to it in that many people don’t have the tools to short debt.
However, this idea is something the whole family can participate in…literally. Series I bonds are US Government savings bonds. Think of them like those old savings bonds your elderly relatives used to give you as a birthday present. The big difference is these bonds pay out based on inflation.
These are the definition of a risk free investment. They are backed by the US Government. In fact, they are more risk free than Treasuries as treasury bonds can subject you to a negative real return. The Series I bonds lock in a real return by adjusting their coupon for inflation.
OK, before I explain more about the mechanics and limitations, let’s get to the punchline.
Just want to make sure you didn’t miss that. NINE POINT SIX TWO PERCENT RISK FREE!!! Now, that’s only for the next six months (it’s 7.12% for the trailing six months) and it will reset lower if you think inflation fades away, but 9.62% risk free returns aren’t supposed to exist in the world. This is really something unique.
How Does It Work?
You can only buy Series I bonds in one of two ways. You can go to TreasuryDirect and buy them online. You are limited to $10K per individual each year. Your spouse can buy individually as well but you can not buy additionally as a joint account, so it’s basically $20K/family.
Note, you can buy for children but only as a gift. So, in theory, you can do another $10K for each child but it is their money so if they want to buy a car when they cash in the bond, you can’t do much about it.
There is one other option which is you can use your tax refund to buy an additional $5000 per return. You may have just missed that window unless you asked for an extension but you have to file an extra form asking for part of your refund to go towards the I bond. One catch here is you get a paper bond, you have to store and not forget about.
The coupon is variable tied to inflation. It changes every six months. The last six months, as mentioned, were 7.12%. It is expected to reset to 9.62% for the next six months. Future coupons will depend on future CPI levels.
Rates are set off the March and September CPI levels. It takes the percentage change in the CPI index for each six month period and multiplies by two to annualize the yield.
Note, if you buy before month end, you will get the 7.12% for the next six months and you will then receive the 9.6% for the six months starting in October. If you wait until May, you will immediately earn the 9.6%, but then reset in November.
Thus, as I understand it, buying in April vs. May is a bet on whether you think November CPI will be above 7.12%. If you think November will be <7%, you should probably buy now.
You can hold I bonds up to 30 years. You can redeem at any time though, in some cases, there are penalties. Namely, if you don’t hold the bond for a full year, you lose all the interest and, if you redeem within 5 years, you sacrifice the final three months of interest. If inflation nosedives, it may be worth paying this penalty.
The optionality is pretty favorable actually, especially if you believe inflation will remain high for years and you build a ladder of new purchases each year.
Taxes on interest can be deferred until redemption which makes it more attractive than most bonds which generate current income (though you are also not collecting the cash interest payment each year either). There will never be capital gains or losses.
You may also be able to avoid taxes if you redeem your bonds to pay for a child’s college. However, there are income limitations on this (~$150K).
Is It Worth It?
That depends on your future view of inflation and your other investment alternatives.
If you are looking at other safe options, you’re getting like 20X what you’d get in a “high yield” savings account so it’s a no brainer. If your alternative is buying corporate bonds, you’re getting ~3X the yield without any risk (of principal loss from credit or capital loss from mark to market).
Alternatively, you can look at higher risk investments like equities, but those come with a lot more volatility. You can probably argue, given the last ten year’s returns, that future stock returns will be lower and may not beat inflation. Why not allocate to the risk free instead?
You also have to consider the purchase limit means this obviously can’t be 100% of your portfolio, so if you’re looking at it on a marginal basis, allocating a small part of your portfolio to a high return, low risk asset makes a lot of sense from a diversification perspective.
Obviously, if you’re in the camp that inflation will be 1% in six months, it makes less sense to get in (though even after forfeiting 3 months of interest you would make about 6% for the year which crushes other low risk alternatives).
Everyone has different needs and risk tolerance, so this may not be for you, but I would suggest it’s something to take a look at it to see if it makes sense for you. If you have any questions, feel free to ask in the comments and I will try to answer or you can check the Treasury’s FAQ page.