Tip #7: Series I Savings Bonds should be included in every investor’s portfolio. This asset purchased directly from the U.S. Treasury without fees is an effective hedge against inflation and higher interest rates.
Characteristics and rules governing Series I bonds: The Series I bond, an accrual bond issued by the U.S. Treasury tied to inflation, is described here.
Key Features of Series I Bonds:
- Backed by the full faith of the U.S. Treasury
- Cannot be redeemed until one year after issue.
- Redemptions prior to five years from issue date forfeiture of one quarter of interest.
- The composite interest rate changes every six months,
- The interest rate is based on two components – a fixed rate and the inflation rate.
- The composite rate is guaranteed to not fall below zero.
- The interest is taxed when the bond is redeemed.
- Bond matures and stops paying interest after 30 years.
- The Treasury limits annual purchases of the bonds to $15,000 per person with a limit of $10,000 on electronic purchases and $5,000 on paper purchases. The paper Series I bonds can only be purchased through refunds from the IRS.
Reasons for Purchasing Series I Bonds:
- Series I Bonds, unlike traditional bonds and bond ETFs, do not fall in value.
- In the current low-interest rate high valuation environment, traditional bonds and stock prices are almost certain to decline in value.
- A retired person with I-Bonds outside of a 401(k) plan can respond to a market downturn by using proceeds from the redemption of I-bonds to fund current consumption rather than disburse funds from a 401(k) plan, which could be temporarily down in value.
- The Series I Bond is a riskless asset. Investors with this asset can reduce holdings of traditional bonds and cash and increase investments in equities.
Difference Between Series I Bonds and TIPS:
Treasury Inflation Protection Securities (TIPS also allow investors to protect returns when inflation and interest rates rise.
Key differences between TIPS and a Series I bond as explained here:
- The TIPS value can fall in an era of deflation. The Series I bond never falls in value.
- The tax on interest from TIPS is paid annually and not deferred to redemption
- TIPS bonds can be sold without forfeiture of any interest at any time. The redemption of a Series I bond is not allowed until after a year from the purchase date and sales prior to five years from the purchase date involve a forfeiture of a 3 months of interest.
- All TIPS can be counted as a liquid asset. Only Series I older than 5 years from issue should be considered liquid.
- Up to $5.0 million in TIPS can be purchased in a single auction. The annual limit on the purchase of Series I Bonds is $15,000.
Thoughts on Series I interest rates:
- The current fixed interest rate on a Series I Bond is 0 percent. The current composite fixed + inflation component on bonds purchased prior to May 2022 is 7.12%. A delay in the purchase of a Series I bond until the second half of the year could result in a permanently higher fixed rate. However, investors would lose an annualized return of 7.12% accruing in May.
- Bonds purchased years ago in a high interest rate environment have a higher current composite rate because the fixed component is higher. People are currently aware of I-Bonds because of the elevated inflation rate. The purchase of I-bonds also makes sense when inflation is low and interest rates are high because the investor will obtain both a higher fixed rate and increases in interest when inflation returns.
Concluding Thoughts: Investors should purchase a Series I bond every year. Investors who maximize receipt of the employer matching contributions to a 401(k) plan can then divert additional investments to a Roth IRA or a Series I Bond. People without a 401(k) plan that allows matching contributions should contribute to a Roth, invest Roth contributions in equities, and divert some funds to the purchase of Series I bonds.