Inflation is hitting American households hard, and it’s also having a big impact on the financial markets. Bond yields have soared, and that has caused the prices of existing bonds to fall sharply, causing even more pain for investors who’ve also seen their stocks lose value so far in 2022.
However, one shining light in a gloomy year for the market has been the U.S. Series I Savings Bond. Also known as I Bonds, these investments have delivered better returns than ever in recent months. And even though the top rate that investors can get for six months is too good to last, early signs suggest that the new rate is still likely to be better than what you can get from most other types of investments.
Why investors are looking more closely at I Bonds right now
Long-term investors know that the stock market has generally outpaced the bond market over the long haul. While stocks offer the ability for shareholders to reap the rewards of a growing business, bonds typically pay only fixed amounts of interest, with the promise of a return of principal at maturity.
Nevertheless, bonds have their place in investment portfolios. Whether it’s covering the portion of your portfolio that you’ll need within five years or it’s just to diversify and reduce the overall volatility of your holdings, embracing the relative safety and security of bonds can be useful. Series I savings bonds can be a great way to fight inflation and provide the benefits of portfolio diversification, especially right now.
The basics on I Bonds
I Bonds are a form of Treasury debt that’s backed by the full faith and credit of the U.S. government. They’re available in denominations as little as $25. Like other savings bonds, I Bonds don’t make cash payments to their investors, instead simply seeing their value go up over time and accruing the interest credited until you cash them in.
The most distinctive feature of I Bonds is that their value is tied to inflation. Every six months, the Treasury looks at the change in the Consumer Price Index over that period. It then applies a formula to determine the interest rate that I Bonds will pay for the next six months.
With inflation having been high lately, the rates that I Bonds have paid have been extraordinary. Late last year, the Treasury announced a 7.12% rate on I Bonds issued from November 2021 to April 2022. The most recent rate reflected accelerating inflation, moving up to 9.62%.
I Bond rates could fall — but not as much as feared
Some investors who are new to I Bonds might not understand that they can’t expect the current high rates to last forever. If inflation eases, then the rates paid in future six-month periods will inevitably be lower than 9.62%. Indeed, I Bonds have been around for a long time, and for much of their history, the rates they’ve paid have been more commonly in the 1% to 2% range, reflecting the calm inflation that we’ve seen over much of the past 20 years.
However, we’re four months into the cycle for determining the rate for the next six months, and already, the increase is substantial. The CPI is up 3.05% between the last I Bond measuring date in March 2022 and the most recent release of inflation data for July. Even if the CPI doesn’t move at all in coming months — perhaps reflecting moderating price increases — that would imply an I Bond rate for the following six months of around 6.1%.
Investors should understand, though, that even that rate might not last far into the future. If inflation gets back under control, future rates could fall sharply. It’s even possible for an I Bond to pay no interest at all for a six-month period, although they can never take money away from you.
Also, I Bonds aren’t perfect investments. You generally can’t cash them in for 12 months after you buy them. After that, if you cash them in during the first five years you own them, you’ll give up three months of interest.
Take a closer look at I Bonds
Even with those shortcomings, though, I Bonds can be a great place for investors to stash cash that they don’t want to put in the stock market. Few investments allow you to fight against inflation as directly as I Bonds do, and that’s especially valuable in today’s uncertain economic environment.
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