Sometimes it’s the simplest do-it-yourself investments that make the most sense, especially as inflation shrinks buying power and stock market continues to disappoint.
The Treasury Department’s inflation-protected I bonds may not be sexy, but they certainly are tempting. If you buy one between now and the end of October, you’ll earn a composite interest rate of 9.62% for the first six months you hold the bonds.
But move fast. The new semi-annual rate, which is calculated from a formula based on the CPI index from March through September, is expected to slip to around 6% in early November when the new rate is set.
“For investors who haven't taken advantage of their I bond purchase allotment so far this year, snapping up the bonds with the current 9.6% interest rate is a smart idea,” Christine Benz, Morningstar's director of personal finance, told Yahoo Money.
“When new I bonds are issued in November, their yields are apt to be a bit lower, reflecting that inflation has ticked down a bit in recent months. Because they offer a fixed rate as well as an inflation adjustment, I-bonds do a better job of protecting investors' purchasing power in an inflationary environment than do nominal bonds, which don't offer an inflation adjustment.”
Why the interest rate expected to drop
The Treasury Department has a special formula for calculating the composite rate of return. It combines a fixed rate set when the bond is issued which never changes over its 30-year life, and a variable rate, which is reset twice a year in May and November and is based on the six-month change of the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy.
The reasoning behind the anticipated drop in the rate is that consumer price increases have eased in recent months with the main CPI index up 0.1% in August.
“The I bond inflation rate that will be announced in November will be based on the difference between the CPI-U figures of March and September,” Ken Tumin, founder and editor of DepositAccounts.com, a bank account comparison site, told Yahoo Money. “We won’t know the September figure until October 13, but based on the figures from March through August, the I bond inflation rate will likely be close to 6%.”
While the composite rate could fall to zero, it’s guaranteed not to fall below that — so you’ll definitely get your initial investment back when you redeem the bond.
How to purchase I bonds
You can buy I bonds with no fee from the U.S. Treasury’s website, TreasuryDirect. In general, you can only purchase up to $10,000 in I bonds each calendar year. But there are ways to bump up that amount, such as using your federal tax refund to directly buy an additional $5,000 in I bonds.
The bonds are bought in increments of $25 or more when you purchase electronically. Paper bonds are sold in five denominations; $50, $100, $200, $500, $1,000.
They earn interest for 30 years or until they are cashed in, whichever comes first. The bonds are government-backed and guaranteed to keep pace with inflation because their return is tied to the Consumer Price Index, and the interest is free from state and local taxes.
You might be able to completely or partially exclude savings bond interest from federal income tax when you pay qualified higher education expenses at an eligible institution or state tuition plan, in the same calendar year you redeem eligible I bonds. See IRS Publication 970 “Tax Benefits for Education.”
The caveats for investors
There are limitations to I bonds. First, they aren’t liquid in the near term.
“Even though they're one of the safest investments around, you need to hold them for at least a year and you'll forfeit a quarter's worth of interest if you redeem an I bond before five years,” Benz said.
And then there’s the ceiling on how much you can invest.
“Purchase constraints are the major caveat with I bonds,” Benz said. “Since each taxpayer can only purchase up to $10,000, plus an additional $5,000 through tax refunds, for larger investors, those purchase limits curb the utility of I bonds as a hedge against inflation. Some investors might want to augment their I bonds with holdings in Treasury Inflation Protected Securities (TIPS).”
For some investors, these bonds can seem like child’s play.
“For someone with a million dollar portfolio, it will provide very limited protection,” Ron Rogé, chairman and ceo of R.W. Rogé & Co. in Naples, Fl., told Yahoo Money. “For someone with a smaller $25,000 portfolio, it will provide much greater inflation protection.”
Moreover, you can't buy I bonds within a traditional IRA, Roth IRA, or employer-sponsored savings plan, such as a 401(k) plan. So you'll need to buy I bonds with savings outside of these programs.
“While we are fans of I bonds, there are some important considerations,” Lisa A.K. Kirchenbauer, a Certified Financial Planner and founder at Omega Wealth Management in Arlington, Va. told Yahoo Money. “On top of the liquidity issues, the website is not easy, and no financial advisor can help you. While this is looking like a great investment right now, there are a number of tradeoffs.”
A few ways to ramp up your I bond purchases
If you’re self-employed, your company, or Limited Liability Corporation (LLC) can purchase up to $10,000 worth of I bonds a year. The business typically must have its own TreasuryDirect.gov account and a taxpayer identification number.
In addition, you can buy I bonds as gifts for your kids if they’re under 18, provided you create a minor linked TreasuryDirect account. You and your spouse can each buy up to an additional $10,000 of I bonds for each one. You can keep the bonds in your account until you're ready to deliver them, say, as a holiday gift this year.
Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon