The Secret Trend - I Bonds Explained*
The I Bond is a type of savings bond backed by the US Treasury on which interest is paid in one of two ways. Interest is calculated by a fixed rate set by the Treasury or by an inflation adjusted rate determined by the Consumer Price Index (CPI). I Bonds have become a hot commodity recently, most likely due to recent inflation. In fact, in April of 2022 alone, over $4 Billion I Bonds were issued. I Bonds are considered a measure by which the value of money can be protected by consumers.
There are numerous advantages to owning I Bonds. One of the most appealing benefits of I Bonds is the minimal risk they pose. Since they are backed by the US government, they cannot lose value unless the government fails.
I Bonds are also great way to offset inflation. Financial buying power decreases during inflation. Since the interest rate on I Bonds are tied to the CPI, there is a greater chance that an investor can earn enough of a return to compensate for the inflation rate. This is the primary reason I Bonds are currently so popular. While money is currently being lost in the stock market, I Bonds keep pace with inflation.
Another advantage is that I Bonds can be used to fund higher education, similar to a 529 plan. A 529 plan is a tax-advantaged savings plan designed to encourage savings for future education costs. In fact, some or all of the interest earned from the I Bond can be excluded from gross income. This is a tax benefit some do not receive from a 529 plan. Consult your tax advisor about any tax savings from using I Bonds for educational costs.
There are some disadvantages to consider. For instance, the rate of the I Bond can be volatile and change often, reaching almost 10% at times. When purchasing an I Bond with a fixed interest rate, the rate is locked and cannot be changed. This may work in your favor or may mean you lose additional interest.
Another important factor to note is that I Bonds are meant to be a long-term investment of 30 years. If they are cashed out early, the soonest that is possible is at a year, the last three months of interest are penalized.
An I Bond must be held for a minimum of five years before cashing out to avoid any penalties. I Bonds should be considered a long-term investment.
A last consideration is that there is a limit to the amount of money an individual can invest in I Bonds per year. You can only purchase up to $10,000 per person in electronic bonds annually and $5,000 with a tax return in paper bonds per year is allowed.
In summary, I Bonds may be a great tool to navigate the current inflation period and to have as part of your investment portfolio. However, over the life span of an average investor’s lifetime, the stock market statistically should outpace inflation. A combination of stocks with added I Bonds to compensate for short term losses from inflation, should put an investor in a more secure financial position.
*Important Note: Nothing in this article constitutes investment, tax and/or financial advice. All investments have risk and may not be suitable for everyone. You should seek advice from an independent financial or tax advisor. The mention of products, services and business in this article does not constitute an endorsement or recommendation.