Should you consider holding some of your cash in these bonds?
Spurred by the record-high inflation, many investors are taking an interest in inflation-pegged bonds, particularly Series I Bonds. With a current 7.12% interest rate (through April 2022), I’ve seen numerous periodicals and other investment brochures recommend these, along with clients inquiring if these bonds have a role in their portfolio.
For those who are curious, here is a summary of Series I Savings Bonds and some advice on where they may fit in your portfolio (hint: cash positions). (Apologies in advance, this Substack is more instructive than it is compelling.)
What is a Series I Bond?
Issued by the U.S. government, Series I Savings Bonds, earn a combined fixed interest rate1 and variable inflation rate (adjusted semi-annually in May and November2). Interest is paid monthly.
You should also know:
Not bought or sold in the secondary market. They can only be obtained directly. Use TreasuryDirect to obtain them electronically. (TreasuryDirect is the main portal through which the U.S. Treasury sells its securities.)
Can be held for as little as one year, or as long as 30 years. If they are sold after fewer than 5 years, the holder sacrifices the last three months worth of interest.
Considered a low-risk investment. Cannot earn less than 0%.
The minimum purchase is $25, maximum is $10,000 per individual.
The fixed rate does not change through the life of the bond. The variable rate does adjust through the life of the bond.
Taxability
Taxable at the federal level, but not at the state and local levels.
Higher Education Exemption—The interest is exempt from federal taxation if it is used for higher education.
Zero-coupon—No interest is paid during the lifetime of the bond. Instead, the interest is added to the value of the bond and future interest is earned on that interest.
Options for taxation—Taxpayers can choose to pay taxes annually on the imputed interest each year (accrual method). Or, taxpayers can choose to pay taxes on the interest accrued at time the bond is sold (cash method).
Pros
Provides an inflation hedge; when inflation rises, so does the variable rate paid on the bond.
Current returns much better than cash holdings.
Interest earned is exempt from state and local taxes.
Value can never be less than zero.
Cons
Inflexible, must hold them for one year to avoid forfeiting interest upon withdrawal.
When inflation drops, their return will drop.
Maximum purchase is $10,000.3 Should consider if the opportunity cost and administrative process to acquire is worth it.
Suggestion
These can be an attractive investment option for individuals with cash positions they do not intend to utilize for at least a year and who have the inclination to go through the administrative process of purchasing and holding these bonds. In this current environment, these bonds will likely earn more than cash, but not outperform equities in the long-term.
Fixed rate determined by the Secretary of the Treasury and announced every six months. This rate does not change throughout the life of the bond.
Variable rate based on changes in the non-seasonally adjusted consumer price index for all urban consumers (CPI-U). This rate changes throughout the life of the bond based on the index.
For individuals who own a business and have established a trust, there are ways to increase the $10,000 limit. You can also utilize a tax refund to purchase up to an additional $5,000 in I-bonds.