Should You Invest in I Bonds for Inflation Protection?

In normal times, a guaranteed 9.62% return on your money with virtually no risk would be impossible. But with inflation at 40-year highs, that’s exactly what Series I bonds are offering. The U.S. Department of Treasury recently announced that I bonds will pay a 9.62% annual interest rate on bonds issued from May through October 2022.

If you’re worried about inflation and recent stock market volatility, you may be wondering if you should invest in I bonds right now. While I bonds can be a great option for those seeking safe investments, there are a few things you need to know before you buy.

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What are I bonds?

I bonds are a type of savings bond that have recently come into fashion due to skyrocketing inflation. The bonds pay a fixed rate — currently 0% — that stays the same throughout the 30-year life of the bond. But the bonds also pay a variable inflation rate that’s adjusted every six months. The 9.62% annual interest rate that I bonds are paying comes entirely from that variable inflation-adjusted rate.

Savings bonds are backed by the full faith and credit of the federal government. Your risk of not recouping the money you invest in I bonds, plus interest, is as close to zero as you can get.

Interest is compounded semiannually and added to the principal value of the bond. So if you buy $1,000 worth of I bonds now, you’d earn 4.81% (half of 9.62%) in the next six months. Come October, the value of your I bonds would be $1,048.10.

But there are some caveats: When you invest in I bonds, you can’t cash out for one year. If you redeem your bonds in the first five years, you’ll also forfeit three months’ worth of interest. For example, if you cashed out after 24 months, you’d only receive 21 months’ worth of interest payments.

You also can’t buy more than $10,000 worth of I bonds electronically through in a given calendar year. However, you can buy an extra $5,000 worth of paper I bonds using your tax refund.

Should I invest in I bonds?

Investing in I bonds makes sense for mid-term goals — think one to five years out — if you’re looking to park your cash in a way that keeps pace with inflation.

For example, suppose you want to buy a home in the next two or three years. You wouldn’t want to invest your down payment money in stocks because the market can fluctuate significantly in the short run and you’ll need your money in a couple of years.

But even the best high-yield savings accounts currently offer interest rates well below 1%. When you keep your money in a savings account, inflation erodes its value year after year.

Investing in I bonds makes sense in this scenario. You don’t need your money right away. Other investments offer the prospect of higher returns, but they’re also riskier. Because you want to be sure the money you’ve saved will be there when you need it, investing it in I bonds is a good move.

Of course, that 9.62% interest rate is likely to be short-lived. The Federal Reserve continues to hike interest rates with the goal of cooling off inflation. As inflation rates fall, so will I bond interest rates. So if you choose to invest in I bonds, you shouldn’t expect to earn 9.62% year after year.

Who shouldn’t invest in I bonds?

It’s essential to build a six-month emergency fund for protection against an unexpected loss of income or major expense. But emergency savings should be liquid, meaning you can access your money quickly without penalty. Since you can’t cash out I bonds for a year, they’re not a good option for your emergency fund.

Having long-term investments is just as important. That 9.62% interest rate may be especially appealing in lieu of the stock market’s lousy performance thus far in 2022. Year to date, the S&P 500 index is down around 13%.

Investing in the stock market has a track record of beating inflation over long stretches of time. The 9.62% interest rate that I bonds are paying is an anomaly — the highest amount paid since the federal government introduced inflation-adjusted savings bonds in 1998. Meanwhile, a 10% return is what you’d expect from the stock market in an average year.

Taking advantage of the unprecedented yield on I bonds can be a savvy move as inflation soars. But I bonds aren’t a substitute for having short-term savings or long-term investments.

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