One of the best current deals in the bond market—Treasury Series I savings bonds—is likely to become less attractive in November when a new interest rate is set for the popular investment.
Individual investors may want to buy the inflation-linked I-bonds before the end of October to get the current 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%. Barron’s estimates, based on the formula used by the US Treasury Department to calculate the semiannual interest rate.
The main disadvantage of I bonds is that individuals can only purchase $10,000 per 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 a year in I Bonds through these entities. I-bonds must be purchased directly from the Treasury through the TreasuryDirect program.
The I bond rate, based on the US consumer price index, reached a record 9.6% for bonds bought from May and continuing through late October as inflation surged in late 2021 and early 2022. But price increases have moderated in recent months with the headline CPI rising 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 compares very favorably to bank CDs.
Bond rates reflect both a CPI-based component of inflation and what the Treasury calls the 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 next six months. The fixed rate will also reset in November and will likely be at or near zero.
May’s rate of 9.6% was based on the CPI index from September 2021 to March 2022.
The Treasury Department uses the non-seasonally adjusted CPI index, which is slightly different than the more prominent seasonally adjusted CPI that grabs the headlines each month. The non-seasonally adjusted CPI rose 4.8% from September 2021 to March 2022. That amount is multiplied by two to reach the 9.6% rate, which applies to bonds bought 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 estimates that consumer prices rose 3% from March to August, the most recent report. Assuming little change in September rates, the new rate should be around 6%.
Investors who buy I bonds before Nov. 1 will receive the 9.6 percent interest 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 safe investment to supplement your emergency funds,” says Ken Tumin, founder and editor of the Bank Deals Blog.
I bonds must be held for at least one year, and bonds redeemed before five years incur a one-quarter interest penalty. Tumin considers the interest penalty modest compared to bank CDs, which typically carry early withdrawal penalties.
Two nice features of I-bonds are that investors can defer paying taxes on the interest payments until they mature—I-bonds can be held for 30 years. And bond interest, like other bonds, is exempt from state and local taxes, unlike bank CDs and corporate bonds.
One risk with I bonds is that inflation will fall and lead to lower interest rates in the coming years. This is a distinct possibility with markets discounting inflation of around 2.5% over the next five and 10 years. But if inflation remains persistently high, I Bonds will look especially good.
Investors who want inflation-linked bonds can also buy Treasury Inflation-Protected Securities (TIPS), which are regularly auctioned by the Treasury Department and available through TreasuryDirect and banks and brokerage firms. They are issued with a duration of five, 10 and 30 years. TIPS are not subject to retail purchase caps.
One 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 rate of inflation plus 1%. TIP prices, however, can fluctuate and have fallen this year as real yields have moved from negative 1.5% to positive 1%. The real yield on I bonds is now zero.
A lower risk way to get TIPS is through ETFs like the
iShares 0-5 Year TIPS Bond ETF
(ticker: STIP) that now has a total return of nearly 10% based on a calculation using Securities and Exchange Commission guidelines. Its real return is around 1.5% and this is supplemented by the inflation adjustment.
Write to Andrew Bary at email@example.com