The I word: inflation… Why is there so much inflation? When will inflation slow down? What is the federal reserve’s and the government’s role in all this? I don’t know (though I do have opinions that I won’t get into here). What I do know is that there are very few vehicles for short-term savings without substantial loss of purchasing power. So, in this article, I’ll dive into I bonds as a practical solution to not get as screwed as holding cash.
Let’s start with a quick tour of the problem facing many savers. Here is a brief glimpse at the past ability to save with banks by comparing average 6-month certificates of deposits to inflation rates.
Historical 6-Month Bank CD Rates vs. Inflation Rates
Here, you can see that 6-month CD rates mostly matched inflation, with five of the eight selected years having higher yields. Saving money without losing purchasing power, what a concept.
Today inflation rates are a whopping 8.54%. How about 6-month CDs? The highest one on this list is a laughable 1.01%. Comparing these rates to our chart of how the rates have trended since 1980 makes one thing abundantly clear: this is not normal.
Investing in the series I savings bond can potentially make the sting of this reality more bearable since they match inflation rates. Let’s walk through scenarios where these can be worthwhile investments and where investing in I bonds should be avoided.
I Bonds as Emergency Savings Accounts
Financial advisors generally advise people to have emergency savings accounts of 3 to 6 months of expenses. The fund is to cover scenarios like losing a job, emergency car repairs, emergency home repairs, medical bills, etc. I don’t believe I bonds would be a suitable replacement for this fund.
The purpose of an emergency savings account is to get the cash immediately. If something horrible like a medical emergency happens, the last thing you’d want to worry about is not having access to your money. Unfortunately, you do not have this luxury when you first invest in I bonds.
I bonds cannot be cashed in before one year is up, with the only exception being in the event of a federally declared disaster. After one year is up, I bonds could potentially serve as a replacement emergency savings account, though I probably would still shy away from this concept for peace of mind.
I Bonds for Additional Savings Goals
In my opinion, the sweet spot for investing in I bonds is for goals that are greater than a year but less than five years. I’ve already talked about the greater than one-year provision above, but why less than five years?
I believe there are better investment alternatives than matching inflation for longer durations. Particularly in real estate, where rental income growth can match inflation, selective stock investing, or stock index investing. (Notice I didn’t say anything about buying traditional treasury bonds). However, these options can have tremendous volatility in the 1-5 year periods, making I bonds more attractive. It’s all about balancing return potential and volatility.
Some savings examples that could fit the 1-5 year criteria would include saving for a house downpayment, tuition, engagements/weddings, student loans (are those payments ever going to start?), large vacations, home improvements, vehicle purchases, etc.
I Bonds Return Potential
Now that we’ve talked about when to buy I bonds, let’s get into what I’m sure you’ve all been waiting for: how much money you can make off these.
First, let me give a caveat, these return numbers may look high, but they will at best maintain purchasing power – by design.
Another caveat is that the yearly max you can invest for an individual is $10K electronically and up to an additional $5K in paper bonds (purchased through your tax refund). For those considering purchasing these bonds as gifts or in their kid’s name, there are ways around these limits. It’s a bit too advanced for me to dive into here, but I’ll share a good article for those looking to learn more.
Okay, okay now we can get back to the making money part. I happen to be writing in a month when it is substantially easier to project 1-year return possibilities than in other months. The rates on the bonds are calculated as follows: 6-month yield = fixed rate + a semiannual inflation rate. The semiannual inflation and fixed rates are updated on May 1 & November 1 of each year.
Bonds purchased in April 2022 will have the old rates from April 2022 to October 2022 and the new rates (coming out on May 1, 2022) from October 2022 to April 2023. The new rates that will be set in May are based on publicly available CPI-U numbers, so it is possible to estimate full-year yields in April and October.
Let’s run through an example of buying the I bond right now to find 1-year yield estimates. Here I’ll use the WSJ estimated semiannual rate for May.
I Bond One-Year Return Without Withdrawl
8.53%! Right in line with inflation, just like the good old days of the 6-month CD & bank savings accounts keeping up. What if you have to withdraw right at the one-year mark? Well, withdrawal before the 5-year mark means you give up the last three months of interest. Let’s look at what the numbers look like.
I Bond One-Year Return With Withdrawl
6.05%! This still sounds a lot better than 1.01% if you ask me!
Summing Up The I Bond Discussion
The I bond is a very attractive (relative to current alternatives, not historically) way to save money for the 1 to 5-year period. Additionally, it is possible to project out 1-year returns with almost exact accuracy in April and October.
Treasury Direct has a clunky government-quality website for purchasing these bonds, but I think figuring it out is worth that additional 5 – 7.5% ($500 – $750 on a $10K investment).