Series I Savings Bonds rates are set to rise to historic levels, again. The Labor Department released Consumer Price Index (CPI-U) data this week that showed prices rising by 8.5% for the 12 months ending Marcy 2022 and 4.81% over the past six months. As a result, the Inflation Rate on I Bonds is expected to rise to a whopping 9.62% in May 2022 (the rate is currently 7.12% annualized).That represents the highest Inflation Rate on I Bonds since they were first introduced in 1998.
How I Bond Rates Are Set
Two factors determine the interest rate on an I bond: A Fixed Rate and an Inflation Rate. Combining these two rates gives us what is known as the Composite Rate.
The Fixed Rate is set based on the date of purchase. Today the Fixed Rate is 0%. The Fixed Rate was above 3% in the late 1990s and early 2000s. It’s been at 0% for much of the past decade.
The Treasury announces the Fixed Rate on I bonds every six months, on the first business day of May and November. The Fixed Rate is an annual rate that compounds every six months. The big question is whether the Treasury will increase the fixed rate in May.
Many predict that the fixed rate will remain at 0%. While I agree with this assessment, it’s a closer call. The real yield on 10-year TIPS (Treasury Inflation Protected Securities) has jumped to from -1.04 to -0.12 in one month.
I suspect the fixed rate won’t rise until real yields on TIPS get about 25 basis points above 0%. This is important for I bond buying strategies (see below). It’s important to understand that the Fixed Rate at the time of purchase applies for the duration of the bond (30 years).
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Unlike the Fixed Rate, the Inflation Rate changes every six months over the life of an I bond. The rate is set based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy. As with the Fixed Rate, the Inflation Rate is set on the first business day in May and November.
Keep in mind that the date new rates apply to a specific I bond depends on the month in which you bought it. Here’s a table of when new rates will take effect:
|Issue month of your bond||New rates take effect|
|January||January 1 and July 1|
|February||February 1 and August 1|
|March||March 1 and September 1|
|April||April 1 and October 1|
|May||May 1 and November 1|
|June||June 1 and December 1|
|July||July 1 and January 1|
|August||August 1 and February 1|
|September||September 1 and March 1|
|October||October 1 and April 1|
|November||November 1 and May 1|
|December||December 1 and June 1|
The Composite Rate is the annualized rate based on adding the Fixed Rate to the Inflation Rate. Through April 2022, Composite Rate is 7.12%. Beginning in May 2022 for the following six months, the Composite Rate will jump to 9.62% thanks to rising inflation.
How I Bonds Work
There are several features of I bonds to keep in mind before investing.
First, you can only buy I bonds directly from the Treasury. They are not bought and sold on the secondary market. This means, among other things, that you won’t find I bonds in an ETF or mutual fund portfolio.
Second, the government imposes a limit on the amount of money that you can invest in I bonds each year. You can invest $10,000 a year per social security number through Treasury Direct. You can also purchase up to $5,000 through your federal tax refund.
Third, you must keep your investment in an I bond for at least one year. You can’t sell the bond back to the government during this time. If you sell before holding the bond for five years, you also lose three months of interest.
Fourth, if you own a business, the business entity can also invest in I bonds. This is something I just learned. My business will be buying $10,000 in I bonds this month.
Finally, you can defer paying income tax on interest until you sell the bond. In addition, you’ll owe no state income tax.
When Should You Buy I Bonds
When you should buy I bonds turns on whether you plan to be a long-term or short-term investor.
For long-term investors, I would buy at the end of April, if you haven’t already purchased I bonds this year. As the chart above shows, you’ll earn the current Inflation Rate from April 2022 through September 2022. Beginning in October 2022, you’ll then earn the new rate of 9.62% for six months.
The key point is that for long-term investors, it’s likely that the Inflation Rate will fall below its current level at some point. As a result, it makes sense to take advantage of the current rate. And while the Fixed Rate will reset in May, it’s unlikely to rise about 0% in my opinion. Of course, there’s no guarantee, but it seems like a reasonable bet in my view.
For investors who plan to sell after one year, I’d follow the same strategy. At the end of last year my recommendation was to wait:
I’d wait until November. I think it’s likely that the Inflation Rate in May 2022 will be higher than the current 3.56%. By waiting until November, investors will receive the 7.12% for six months, followed by the new rate set in May of next year. While it’s certainly possible that the Inflation Rate next year could fall below the current 3.56%, I view that as unlikely given the current trends in the CPI.
Today I’m less certain that the next inflation adjustment will be as attractive. There are already some signs of core inflation moderating. Just keep in mind that accurately predicting inflation and interest rates is impossible. For me today, a “bird in the hand” rules the day.
Keep in mind that if you sell after one year, you’ll lose 3 months of interest. Even so, the return will far exceed what savers can earn on a deposit account.
I Bonds vs CDs
Given the current and upcoming yields on I bonds, they are significantly better than even the best CD rates. That’s true even if one plans to sell the I bond after one year and incur the 3-month interest penalty. The key difference is that with I bonds, you cannot liquidate for the first year. With a CD, you can always withdraw your money, subject to an interest penalty.
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