Inflation sucks. There is no eloquent way to express it.
Gas costs more than wine, a Camry costs more than a Corvette in 2019, and America’s favorite dollar store (at least it was for me), Dollar Tree raised most of its merchandise to a base price of $1.25 to fight. with inflation.
Either way, you’ve read Money Under 30, which means you probably already know how to effectively budget and save money without giving up on your lifestyle.
The bigger problem, however, is that the money you save by budgeting—the money that stays in your checking and savings accounts—still loses value due to inflation.
Let’s do something about it.
Invest in stocks? Possibly, but risky.
Invest in crypto? It is also possible, but also risky.
If only there was a place where you could store money with zero risk and earn interest at the same rate as the rate of inflation. Thus, it will not depreciate, and when inflation subsides, it can simply be pulled out.
Well, fortunately, such a thing does exist.
What is a Series I US Treasury Savings Bond?
Before we talk about what makes I Bonds great, let’s quickly recap what bonds are in general.
What are bonds, again?
We wrote a whole breakdown of bonds describing how they work and why they are a healthy part of a balanced portfolio, but here’s the TL; D.R.
A bond is similar to an IOU. You lend money to an organization and they promise to pay you back by a certain date (known as the “maturity date”) with a predetermined amount of interest. Bonds also typically pay interest every six months, generating a nice passive income.
On the downside, interest rates on bonds are usually low (between 1% and 5%) and your money is tied up until the maturity date (or until you sell the bond).
Now bonds issued by the US Treasury, or Treasury bonds for short, are popular because they carry little to no risk. However, they also pay some of the lowest interest rates below 2%.
“Wait. This is lower than inflation, that is, I would lose money lending it to the government!”
They hear you; That’s why the Treasury offers a unique inflation-fighting tool called I Bonds.
How do bonds work?
Series I US Treasury Savings Bonds, or simply I Bonds for short (fortunately), are bonds that help Americans protect their money from inflation.
The basic mechanics of I Bonds is pretty simple: every six months, in November and May, the Treasury adjusts the I Bonds interest rate to try and match the rate of inflation.
Americans then buy low-risk I bonds to protect their money from depreciation, and at least 12 months later, cash out their bonds when things go wrong.
Image Source: Chris Butch using imgflip
Naturally, due to the sharp jump in inflation in the United States, bond rates have also risen sharply right now. Here are the latest and upcoming bets:
- May to October 2021: 3.54%
- November to April 2022: 7.12%
- May to October 2022: 7% to 9% (forecast).
The icing on the cake is that your interest accrued on I bonds is exempt from state and municipal taxes. They are potentially even free of federal taxes if you spend your interest on tuition or student loans.
However, I Bonds are not perfect and they do have a few drawbacks to consider.
What are the disadvantages of buying I Bonds?
Unfortunately, you can’t just treat your I Bond investment like a high-yielding savings account, withdrawing funds whenever you want to pay bills or buy a PS5.
Rather, I Bonds have some limitations such as:
1. You can only buy I Bonds up to $15,000 per year.
The Treasury will sell I bonds up to $10,000 per year per Social Security number. You can buy another $5,000 with a maximum $15,000 annual tax return.
2. Your money is frozen for at least one year (or five, no penalty)
The bonds technically have a maturity of 20 years, but you can cash them out without penalty in as little as five years.
Cash out between the first and fifth years and you will receive a small penalty of three months’ interest.
Finally, you cannot cash out an I Bond within 12 months of purchase. At this point you could sell most bonds to recoup your investment, however…
3. You cannot sell I Bonds on the secondary market
Simply put, there is no secondary market for I Bonds. They are not transferable. The only entity you can cash out I Bond with is the US Treasury.
And you won’t get cash at the same time because…
4. I Bonds are not fixed income
As mentioned, most bonds actually pay you accrued interest every six months, which is why retirees love them.
However, I Bonds are more like no-dividend stocks. Instead of giving you a check every six months, the Treasury reinvests your profits to keep accumulating.
Compound interest will increase the amount of money you get when you cash out, but it also means no passive income.
5. Bond interest rates could fall
From a technical standpoint, bond interest rates are not just something the Treasury is trying to match with inflation. I mean it’s the end goal, but it’s not a formula.
The actual formula for calculating the interest rate on bonds I includes both the fixed rate and the inflation rate:
I Compound interest rate on a bond =
flat rate + (2 x biannual inflation rate) + (flat rate x biannual inflation rate)
So what does this mean for you?
This means that, in theory, the Treasury’s fixed rate should provide a safety margin so that your interest rate doesn’t fall too far when inflation falls.
But here’s the problem: The Treasury’s fixed rate is 0.00%, and it’s been that way for a while. So there is no pillow. If inflation falls to 0% in 2022, the I Bond interest rate will also fall to 0%.
Given the Fed is hard at work on curbing inflation, does that mean bonds won’t be a bargain in 2022?
Not at all. In fact, just the opposite.
Despite the cons, here’s why I Bonds is so popular right now
Despite the “risk” that inflation could slow down in the second half of 2022, I Bonds is a smart buy in 2022 for several reasons.
- If you buy I Bonds before the end of April, you are locked up for six months at 7.12% per annum. These are simply unheard of zero-risk investment returns.
- Even if inflation corrected to 0% and bond interest rates plummeted, you would still average 3.56% per annum for the first 12 months. Again, damn good for a risk-free purchase.
- Finally, no one expects inflation to fall anytime soon. The Fed has a 2% target this year, but economists are very skeptical. “We expect the consumer price index to remain at about 4% by the end of this year,” said Sara House, senior economist at Wells Fargo.
(The CPI is a consumer price index that predicts inflation.)
Bonds are a smart buy right now, but “smart” doesn’t always mean “universal.”
Are they the right buy for you? If yes, how do you buy them?
Is I Bonds right for you?
Buying I Bonds can be a move if
- You have up to $10,000 in a checking or savings account with a low interest rate,
- You don’t know what else to do with it, and
- You definitely won’t need it for the next 12 months.
Indeed, no. 1 disadvantage of buying I Bonds is not the risk (since there is none), but liquidity. Uncle Sam will protect your money from inflation, but won’t let you touch it for at least a year.
If you don’t mind putting $1,000, $5,000, and even up to $15,000 in zero-risk investments to protect them from inflation – and not see them for a while – buying I Bonds is a smart choice.
How to buy bonds I
You can buy I Bonds in two ways:
- By submitting IRS Form 8888 with your 2021 tax returns, telling them that you would like to spend some or all of the refund on I Bonds (up to $5,000).
And/or
- Buying them directly from the government (up to $10,000).
Setting up an account with Treasury Direct takes about 10 minutes. From there, the process is quite simple, and they do a pretty good job of helping you get through it.
essence
If you want to protect your money from inflation, buying I Bonds is a lesser known but very wise option.
Yes, Money Under 30 can help you invest them in other ways to potentially make much higher returns (buying index funds comes to mind), but I Bonds are guaranteed..
Thus, when inflation is high, bond interest rates become terrible in equal but opposite ways. If you have money lying in a pile, let Uncle Sam protect it.
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