Why You Should Invest in Series I Savings Bonds
Now that the bull market is over and inflation is rising, there's accelerating interest in inflation protected securities. Inflation adjusted I Savings Bonds are issued by the federal government to preserve the purchasing power of your money.
"Series I Savings Bonds are intended to do exactly what their name implies -- offer a savings vehicle that earns interest in the form of debt to the issuer (the U.S. government)," says Michael Olivia, certified financial planner at WestPac Wealth Partners and Guardian in San Diego.
But, unlike a typical bond with a fixed coupon payment, I bonds interest payments change along with the inflation rate. So, as prices rise and the purchasing power of the dollar declines, the bonds will raise their interest payments twice per year. The increasing I savings bonds interest payments protect investors purchasing power from the ravages of inflation.
[See: 7 Best Corporate Bonds to Buy and Hold for 2019.]
The TreasuryDirect website offers a portal to study and buy I Savings bonds. These inflation bonds are unique in the way they earn interest. I bonds offer a composite interest rate including the fixed interest rate, set at issue, plus an inflation interest rate that adjusts every six months.
The fixed interest rate is set at purchase and remains constant for the life of the bond. For example, bonds issued from Nov. 1, 2018, through April 30, 2019, earn 0.5 percent interest per year. The current semiannual inflation interest rate payment is 1.16 percent. The present I bonds composite interest rate is 2.83 percent, the fixed rate plus the semiannual rate, paid twice. The interest rate changes the month of issue and again six months later. So, a bond bought in February will receive a potential rate change Feb. 1 and Aug. 1.
A savings bond calculator on the TreasuryDirect website quickly calculates existing I bond values.
All isn't perfect with I bonds. Investors can only purchase up to $10,000 worth of I bonds annually online and an additional $5,000 worth of paper I bonds with proceeds from their tax refund. So, large investors might consider investing in another government issue inflation hedge, the Treasury's inflation-protected securities (TIPS).
Another disadvantage of I bonds is that they must be owned for one year before they're eligible for redemption. Also, bonds sold during the first five years will sacrifice three months interest.
Yet, in light of the choppy stock market and despite the restrictions, attention to I bonds is growing.
[See: 10 of the Best Stocks to Buy for 2019.]
Anthony Montenegro, investment advisor at the Blackmont Group in Orange County, California, says I Savings Bonds offer a way to stay on the stock market sidelines as prices tumble. After one year, "investors can cash out their Series I bonds and reinvest that cash toward better-yielding equities and longer term corporate or municipal bond issues as well as other opportunities. In the meantime, they will earn a better rate than (investing) in a money market (mutual fund)," he says.
Steven Jon Kaplan, CEO of New York-based True Contrarian Investments, says I bonds generate the highest returns when purchased during periods of high stock valuations and above-average U.S. Treasury yields.
"I only purchase I-Bonds when they are especially good values," he says. "I'm currently buying a few for my clients but expect to be a more significant buyer in 2019 and perhaps for part of 2020."
Kaplan also likes the favorable tax treatment of I bonds. I bond interest is free from state and local taxes, a benefit for investors in high tax states like New York and California. Further, tax is paid on the accumulated interest from I bonds, only upon sale. "You can choose a calendar year (to sell the bonds) when your overall taxable income is below average so you will pay federal tax at a lower marginal rate," Kaplan says.
With a typical bond, as interest rates rise, the principal value declines. This isn't the case with I bonds, Olivia says.
"I Bonds function a bit differently in that they are non-traded bonds, meaning you won't find them for sale on the open market. Instead, these bonds are redeemed with their issuer, the U.S. Treasury. This eliminates some of the liquidity and market price concerns for investors, as there is always a buyer, willing to redeem the bond at face value, plus accrued interest", Olivia says.
This gives I bonds another layer of security for the investor. When buying an I bond, investors are certain that the bond can be redeemed at face value, and that during ownership, the value will keep up with pace of inflation.
[Read: How to Stay Confident in a Shaky Market.]
As inflation ramps up, along with interest rates, the I bond becomes more attractive. These fixed income investments compete favorably with money market mutual funds and certificates of deposit. Also, with the fixed principal value, they're more desirable for savers than volatile corporate or municipal bonds.
Yet, there are reasons investors might not be aware of I bonds. They are sold by the government and an investment advisor won't receive a commission upon purchase or sale. Also, with recent low inflation and interest rates, I Bonds interest payments weren't as desirable as they are today.
As inflation heats up, along with interest rates, investors might consider adding I bonds to their portfolios.
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