What will deliver higher returns over the next 12 months, I bonds or bitcoin? A year ago such a question would have been silly. Today, not so much. Bitcoin
Here’s what you need to know.
I bond rates set to exceed 9% next month
I Bond Basics
First introduced in 1998, I bonds are issued by the U.S. government. Investors purchase I bonds directly from the government via the TreasuryDirect.gov website. Unlike most other U.S. bonds, however, I bonds are designed to protect savers from the ravages of inflation.
They accomplish this by adjusting the interest rate twice a year (May and November) based on changes in the CPI. 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.
Today the Fixed Rate is 0%. Not very exciting and likely to remain at zero percent when the Treasury announces new rates in May. The Inflation Rate, however, will jump to an annualized 9.62% based on the latest CPI numbers released early this month.
Beyond the interest rate, here are some key features of I bonds you should know:
- There is a $10,000 per person limit on the amount one can invest in I bonds each year
- Individuals can purchase an additional $5,000 in I bonds through their tax refunds
- Trusts and companies can also purchase I bonds
- I bonds cannot be redeemed for 12 months
- Redeeming I bonds before five years will result in a penalty equal to 3 month’s of interest
- I bonds must be bought and sold directly with the government. Therefore, you won’t find them in a mutual fund or ETF.
Buy I Bonds in April
The current composite rate on I bonds is 7.12%. This lower rate has some questioning whether they should wait until next month do buy I bonds. The answer is a resounding no. Here’s why.
The Treasury announces I bond rates in May and November. When the new rates apply to a specific I bond, however, depends on when you purchase them. The key thing to remember is that you’ll never miss out on existing or new rates.
If you buy now in April 2022, you’ll receive the current Composite Rate of 7.12% for a full six months. That’s true even though the Treasury will announce the new rate in about two weeks.
More importantly, you won’t miss out on the new rate. Once you’ve owned the I bond for six months, you then begin receiving the Composite Rate to be announced in May (believed to be 9.62%). And you’ll receive that rate for a full six months as well. The result is an 8.37% rate for the first year.
You can check out a helpful table of when I bond rates change based on the purchase date here.
I Bonds vs TIPS
Both I bonds and TIPS (Treasury Inflation Protected Securities) protect investors from inflation. They do so, however, in two very different ways.
As noted above, I bonds protect us from inflation by adjusting the interest rate paid on the bond based on changes in CPI. In contrast, the interest rate on TIPS stay the same for the life of the bond. Instead, the government adjusts the face value of the bond based on CPI. The fixed interest rate is then applied to the adjusted face value.
There’s another important difference. Unlike I bonds, TIPS can be bought and sold in the secondary market. As a result, you can purchase TIPS via mutual funds and ETFs. In this way, TIPS are easier to purchase, particularly in larger amounts.
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 and are limited in the amount you can purchase. With a CD, you can always withdraw your money, subject to an interest penalty.
Final Thoughts
I bonds today are arguably the single best risk-adjusted investment one can make. Frankly, navigating the government’s website to purchase I bonds is not a walk in the park. But with rates set to jump above 9%, it’s well worth the effort.
