What’s The Fuss With I Bonds?

Torsten Asmus

When inflation started picking up last year, every blog writer and financial columnist started writing about U.S. Treasury I Bonds. For example, in a recent CNBC article Suze Orman said, “I Bonds are the one investment everyone should have right now.” At the risk of being ostracized by the financial intelligentsia, and persecuted by I Bond “Lovers” on Seeking Alpha, the following are a few blemishes on this perfect “rose”.

I Bonds are U.S. Treasury-guaranteed bonds that pay a rate linked to the inflation rate (Urban Consumer Price Index). In fact, the “headline” interest rate today for new Series I Savings Bonds is 9.62% (annualized) for bonds bought before the end of October (for much more info, please go to the TreasuryDirect website). However, there is much more to this rate than meets the eye!

Importantly, the quoted “annualized” rate is misleading for an unsophisticated investor. In fact, today’s headline rate of 9.62% is really only 4.81% for the 6 months through March 2023. At March 2023 the rate will be replaced for 6 months by whatever the inflation rate is (plus a fixed rate component that is currently 0.00%). So, it really is a version of a simple 6-month bank CD that re-sets every 6 months for the next 30 years. Granted, the 4.81% rate today is still pretty good for a 6-month CD! But, if the Fed is successful in reducing inflation, it is a certainty that the rates for these I Bonds will be lower at the next rate reset.

Additionally, like bank CDs, as you would expect, there are restrictions. For I Bonds that are cashed before 5 years, you lose the last three months of interest as a penalty. Also, none of the I Bond interest earned is “spendable” unless the I Bond is redeemed (with the income federally taxed); a negative if you plan to use the income to help fund living expenses.

Secondly, for investors with a high net worth, these really aren’t worth the bother. The Treasury limits annual purchase amounts to $10,000 per social security number. So, for a well-to-do investor with $1,000,000 saved for retirement, that equals only a 1% portfolio allocation; not something to get too excited about from a total portfolio perspective. Plus, it is illiquid for 5 years (within when a 3-month interest penalty is assessed) making it not a very good high yielding cash proxy. Of course, if your portfolio is smaller it could have a larger portfolio impact and be more meaningful or, conversely, be less meaningful if your portfolio is larger.

Additionally, if you are younger (with a 10+ year investment horizon) and have a smaller investment portfolio and are saving for retirement it is probably better for you to ignore bonds altogether and have a retirement portfolio invested 100% in equities, anyway!

So, like any investment, I Bonds have pros and cons and whether it makes sense for you depends on your investment profile and goals. Yes, the 4.81% rate today for 6 months is pretty good and should be considered as an investment, but it is not for “everyone.”

I Bonds make the most sense for someone with a small investment portfolio who doesn’t need the money (or earnings from it) within the next 5 years and is looking to supplement their current fixed income allocation with an inflation-adjusted component. They must recognize that if inflation moderates so will their earnings such that it might underperform bank CDs or other fixed income over their time horizon. It could be that today’s 4.81% could end up being some kind of a “teaser rate” to get you in the door! For a large investment portfolio, the $10,000 maximum annual limit plus all the other caveats make it not worth the trouble.

Note: I Bonds are only available as a do-it-yourself purchase directly from the U.S. Treasury. Financial advisers cannot buy these investments for client accounts.