Should you invest in I bonds for inflation protection? | personal finance

(Robin Hartill, CFP®)

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

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

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What are I bonds?

I bonds are a type of savings bond that has recently become fashionable due to skyrocketing inflation. The bonds pay a fixed rate, currently 0%, which remains the same for the 30-year life of the bond. But the bonds also pay a variable rate of inflation that adjusts every six months. The 9.62% annual interest rate paid by the I bonds comes entirely from that variable rate adjusted for inflation.

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Savings bonds are backed by the full faith 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 you can get.

Interest is compounded semiannually and added to the principal value of the bond. So if you buy $1,000 in I Bonds now, you would earn 4.81% (half of 9.62%) over the next six months. In October, the value of your I bonds would be $1,048.10.

But there are a few caveats: When you invest in I bonds, you can’t withdraw any money for a year. If you redeem your bonds in the first five years, you’ll also lose three months’ interest. For example, if you made a withdrawal after 24 months, you will only receive interest payments for 21 months.

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

Should I invest in bonds I?

Investing in I bonds makes sense for medium-term goals (think one to five years) if you’re looking to park your cash in a way that keeps pace with inflation.

For example, suppose you want to buy a house in the next two or three years. You don’t want to invest your down payment money in stocks because the market can fluctuate significantly in the short term and you’ll need your money in a couple of years.

But even the best high-yield savings accounts today offer interest rates well below 1%. When you keep your money in a savings account, inflation erodes its value 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 higher returns, but are also riskier. Because you want to be sure that the money you’ve saved will be there when you need it, investing it in I bonds is a good move.

Of course, that 9.62% interest rate is likely to be short-lived. The Federal Reserve continues to raise interest rates with the aim of cooling inflation. As inflation rates fall, so will bond interest rates. Therefore, if you choose to invest in I bonds, you should not expect to earn 9.62% year over year.

Who should not invest in bonds I?

Creating a six-month emergency fund is essential to protect yourself against an unexpected loss of income or a major expense. But emergency savings must be liquid, meaning you can access your money quickly without penalty. Since you can’t collect 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% interest rate may be especially attractive in lieu of the stock market’s dismal performance so far in 2022. The S&P 500 Index is down about 13% so far this year.

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

Taking advantage of unprecedented I bond yields may be a smart move as inflation soars. But I bonds are not a substitute for having short-term savings or long-term investments.

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