One of the best deals in the bond market at the moment – the Treasury’s Series I savings bonds – is likely to take off in November when a new rate is set on the popular investments.
Individual investors may want to short the inflation-linked I bonds before the end of October to get the current interest rate of 9.6% for the first six months. The new rate, which applies to bonds bought in November, is likely to be closer to 6%, ie Barron’s estimates, based on the formula used by the US Treasury to calculate the semiannual rate.
The biggest disadvantage of I bonds is that individuals can only purchase $10,000 a year, although an additional $5,000 can be purchased using proceeds from federal tax refunds. And Americans who own certain businesses can buy $10,000 annually in I Bonds through those entities. The I bonds must be purchased directly from the Treasury through its TreasuryDirect program.
The rate on I bonds, based on the US consumer price index, was a record 9.6% for bonds purchased beginning in May and continuing through the end of October due to a surge in inflation in late 2021 and in early 2022. But price increases have eased in recent months with the main CPI index up 0.1% in August. The Treasury has been selling I bonds since 1998.
“You should buy now,” says John Scherer, founder of Trinity Financial Planning in Middleton, Wis. He says the current rate is very favorable compared to bank CDs.
Bond rates reflect an inflation component based on the CPI index and what the Treasury calls a fixed rate, which is now zero. The inflation rate is set twice a year in early May and November and applies to bonds purchased in the following six months. The fixed rate will also reset in November and is likely to be at or near zero.
The May interest rate of 9.6% was based on the CPI index from September 2021 to March 2022.
The Treasury uses the non-seasonally adjusted CPI index, which is slightly different from the more significant seasonally adjusted CPI that garners headlines each month. The non-seasonally adjusted CPI rose 4.8% from September 2021 to March 2022. That amount is doubled to arrive at the 9.6% rate, which applies to bonds purchased from May to October of this year.
The new rate, to be announced in early November, is based on the CPI index from March to September. Barron’s it calculates that consumer prices were up 3% from March to August, the latest report. Assuming little change in September prices, the new rate should be around 6%.
Investors who buy I bonds before November 1 will receive the 9.6% rate for the first six months they hold the bonds and then the new rate for the next six months.
“I bonds are definitely a great and safe investment to add to your emergency funds,” says Ken Tumin, founder and editor of the Bank Markets Blog.
I Bonds must be held for at least one year and there is a penalty of a quarter interest on bonds redeemed before five years. Tumin reckons the interest penalty is modest compared to bank CDs, which usually carry early withdrawal penalties.
Two nice features of I-bonds are that investors can defer paying taxes on the interest payments until maturity I-bonds can be held for 30 years. And I bond interest, like other Treasuries, is exempt from state and local taxes, unlike bank CDs and corporate bonds.
I bonds carry a risk of falling inflation and lower interest rates in the coming years. That is a distinct possibility with markets discounting inflation of around 2.5% over the next five to 10 years. But if inflation stays very high, Bonds will look very good.
Investors who want to buy inflation-linked bonds can also buy Treasury inflation-protected securities (TIPS), which are regularly auctioned by the Treasury and are available through TreasuryDirect and banks and brokerage firms. They are issued with maturities of five, 10 and 30 years. TIPS are not subject to caps on purchases by individuals.
An advantage of TIPS over I Bonds is that they now offer a real, or inflation-adjusted, interest rate of about 1%, meaning holders get the inflation rate plus 1%. TIP prices, however, can fluctuate and fall this year as real yields have moved from negative 1.5% to positive 1%. The actual yield on I bonds is now zero.
A lower-risk way to own TIPS is through ETFs like the
iShares 0-5 Year Bond TIPS ETF
(ticker: STIP) now has a total yield of nearly 10% based on a calculation using Securities and Exchange Commission guidelines. The actual return is about 1.5% and that is supplemented by the inflation adjustment.
Write to Andrew Bary at email@example.com