What’s wrong with I bonds?


Torsten Asmus

When inflation started to rise last year, every blogger and financial columnist started writing about US Treasuries. For example, in a recent CNBC article, Suze Orman said, “Bonds are the only investment anyone should have right now. At the risk of being ostracized by the financial intelligentsia and persecuted by I Bond “Lovers” on Seeking Alpha, here are some imperfections on this perfect “rose”.

I Bonds are bonds guaranteed by the US Treasury that pay a rate linked to the rate of inflation (urban consumer price index). In fact, today’s “all-in” interest rate for new Series I Savings Bonds is 9.62% (annualized) for bonds purchased before the end of October (for more information, please see the TreasuryDirect website). However, there is a lot more to this rate than meets the eye!

It is important to note that the “annualized” rate indicated is misleading for an unsophisticated investor. In fact, the current headline rate of 9.62% is actually only 4.81% for the 6 months until March 2023. In March 2023, the rate will be replaced for 6 months by the inflation rate whatever it is (plus a fixed rate component which is currently 0.00%). So it’s really a version of a simple 6 month bank CD that resets every 6 months for the next 30 years. Admittedly, the rate of 4.81% today is still quite good for a 6-month CD! But, if the Fed succeeds in reducing inflation, it is certain that the rates of these I bonds will be lower at the next rate reset.

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

Second, for investors with high net worth, it really isn’t worth it. The Treasury limits annual purchase amounts to $10,000 per Social Security number. So, for a wealthy investor with $1,000,000 saved for retirement, this equates to just a 1% portfolio allocation; not something too exciting from a total portfolio perspective. Moreover, it is illiquid for 5 years (inside of which a 3 month interest penalty is imposed), which makes it a very good high yield cash indicator. Of course, if your portfolio is smaller, it could have a greater impact on the portfolio and be more significant or, conversely, be less significant if your portfolio is larger.

Also, if you’re younger (with an investment horizon of more than 10 years) and have a smaller investment portfolio and are saving for retirement, it’s probably best for you to skip it altogether. bonds and having a retirement portfolio invested 100% in equities, anyway!

Thus, like any investment, I bonds have advantages and disadvantages and their suitability depends on your investment profile and your objectives. Yes, the rate of 4.81% today for 6 months is pretty good and should be considered an investment, but it’s not for “everyone”.

I Bonds make more sense for someone with a small investment portfolio who doesn’t need cash (or income) in the next 5 years and is looking to supplement their current fixed income allocation with an inflation-adjusted component. They need to recognize that if inflation slows, their earnings will decline, so they could underperform bank CDs or other fixed income securities over their time horizon. It could be that today’s 4.81% ends up being some sort of “hit rate” to get you in! For a large investment portfolio, the maximum annual limit of $10,000 plus all the other caveats make it not worth it.

Note: I Bonds are only available as a do-it-yourself purchase directly from the US Treasury. Financial advisors may not purchase these investments for client accounts.


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