I Bonds: A Novel Way to Save Cash

Few investments provide a guaranteed rate of return over 7%. U.S. Treasury Series I Bonds are currently paying out at 7.12%, with that trend expected to continue.

Today’s post is short and sweet, and perhaps worthy of your time.

A Note on Inflation

In today’s high inflation environment, it is easy for me to make a strong case for investing. As the common narrative goes, we’ve always been investing to outpace inflation. In a 2% inflation environment, however, it’s an out-of-sight-out-of-mind theoretical problem. When a $20,000 car will cost only $20,400 next year, the time-value of money seems valueless.

Predictably, as inflation started to climb in late spring of 2021, a few folks noticed. By late 2021 and early 2022, the “I word” was dominating the headlines and on the frustrated and pursed lips of damn near everyone. 

For many, this is the first time in a generation that inflation has even entered the common vernacular. Indeed, in my 37 years on the vine of life, inflation has been a non-concern, hovering at about 2% on average.

Check out recent inflation rates below…

source: tradingeconomics.com

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Now that this year’s $20,000 car might cost $28,000+ next year (the yearly inflation on used cars is over 40%!), there’s a hell of a lot more incentive to get that car now.

Inflation is Healthy, until it Isn’t

Does inflation universally suck? Only at high rates. 

A reasonable level of inflation (i.e., 2-3% yearly) is healthy for an economy. If I know that my car will be more expensive next year, I’m incentivized to buy it now. 

Conversely, in an economic state of deflation, or negative inflation rates, I might wait to buy a car that I speculate will be cheaper in the future, lowering spending and hampering the economy. Low levels of inflation encourage steady and healthy levels of consumerism.

What is an I Bond?

Despite all the negative news about inflation, there is indeed a silver lining. And that silver lining is the U.S. Treasury Series I Bond.

Even though we’ve (hopefully) successfully demonstrated that compound growth can be used to outpace inflation, there is still value in saving in less volatile and more readably liquidable accounts.

For those seeking a way to either (1) save for medium-term objectives (ideally five years or longer); or (2) expand their bond allocation in new directions, look no further than today’s high-yielding I Bonds.

I bonds are bonds issued by the U.S. Treasury that earn interest by combining a fixed rate and a variable inflation rate.

The really exciting news is that the combined interest rate for I Bonds issued between November 2021 and April 2022 is 7.12%*.

*7% yearly growth is a healthy number for the stock market, and exceptional for a bond.

Calculating I Bond Interest Rates

I Bond interest rates are composed of two parts:

1. A fixed rate determined by the U.S. Treasury Secretary. The fixed rate portion of the I Bond will not change after it is purchased.

2. A variable interest rate calculated twice yearly, which is based on changes in the nonseasonally adjusted CPI for all Urban Consumers (CPI-U) for all items. This rate will change every six months. The variable rate is only guaranteed until the next rate is issued. New rates are issued on May 1 and November 1 each year.

The I Bond composite interest rate is calculated using the following formula:

Fixed Rate = F

Semiannual Inflation Rate = SI

Composite Rate = [F + (2 x SI) + (F x SI)

The composite rate for bonds issued between November 2021 through April 2022 is determined below:

Fixed Rate = F = 0.00%

Semiannual Inflation Rate = SI = 3.56%

Composite Rate = (0.0000 + (2 x 0.0356) + (0.0000 x 0.0356)

Composite Rate = (0.0000 + 0.0712 + 0.0000)

Composite Rate = 0.0712 = 7.12% (Bam!)

For more on I Bond interest rate calculations, this resource from TreasuryDirect is helpful.

When is Interest Earned on I Bonds?

Interest is earned every month and is compounded twice annually.

Twice each year, in May and November, the earned interest from the bond over the previous six months is added back to the principal value. Interest for the subsequent six months is then calculated using this elevated principal.

Once bonds are cashed out, the interest and the original principal are paid.

How Long Must I Bonds Be Held?

I Bonds must be held for at least one year. Interest is earned for 30 years from the purchase date.

If I Bonds are cashed out before five years, the previous three months of interest are lost.

For example, if I cash out my I Bonds after 24 months, I will receive my principal plus 21 months of interest.

I Bond Tax Consideration

I Bonds are taxed as federal income tax, but are not subject to local or state taxes. Federal taxes are waived, however, if I Bonds are used for higher education.

I Bonds: How Much Can I Buy?

For digital I Bonds, the minimum purchase price is $25. Paper bonds are also available for a minimum purchase of $50, but who does that?

The maximum purchase of digital bonds is $10,000 per year for an individual, or $20,000 for a couple (but must be purchased by each individual).

One can also invest up to $5,000 from Federal tax returns.

Where Can I Purchase I Bonds?

I bonds are only available online from the U.S. Treasury at TreasuryDirect.

Should I Hurry and Buy I Bonds?

Well, I’m not here to give advice.

But here’s the deal: The 7.12% rate is good through the end of April 2022. Inflation rates have continued to rise since the last I Bond rates were announced in November of 2021. As such, the inflation rate portion of the I Bond will likely remain high.

So, if I were a betting man, I’d wager that the May 1 rates will be just as high, if not higher than 7.12%, ensuring another six months of exceptional bond yields.

Even if the May 1 variable rate falls to 0% (which it won’t) and the bonds are cashed after one year (losing the last three months of interest) the return for the year will still be 3.56%. You won’t find a cash savings account with an interest rate even close to that ballpark.

The I Bond composite interest rate is only guaranteed for six months. In this high inflation environment, however, I Bonds will very likely generate healthy returns (7+%) for the remainder of 2022.

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For more on I Bonds, please check out this article from TreasuryDirect, this one from Forbes, and a great primer from Investopedia. Extra credit goes to Emily, who helped nudge my wife and I in this direction.

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