Could Series I Savings Bonds yield a decent return against high inflation and compared to current alternatives in high yield savings accounts and the stock market?
With inflation hitting new 40 year highs of 8.6% CPI Inflation as of May 2022, you may be wondering if there’s any safe place to put your hard-earned money and not lose so much against inflation.
Unlike most of the time in the last decade, the Series I Savings Bonds could finally be compelling given how much stock market turmoil we’re seeing and the Federal Reserve looking to combat raging inflation with half point rate hikes through September 2022.
What is it? The Series I Savings Bonds is an interest-bearing US government savings bond that gives a return to the investor based on a combination of a 1) fixed interest rate + 2) semiannual variable inflation rate.
First, the Series I has a fixed interest rate of 0% throughout its entire life if you hold it for the maximum earning period of 30 years. The actual return that a Series I bond gives depends on what the current level of inflation is.
The inflation level that dictates the interest rate for the Series I is the Consumer Price Index for all Urban Consumers (CPI-U).
From May 2022 through October 2022, this semiannual composite rate on the Series I is 9.62%! This is up by 2.5% from the 7.12% rate that the Series I bond issued at between November 2021 through April 2022.
If inflation goes to zero or negative, then you risk getting no return on the Series I bond. However, you will never lose the face value of what principal you originally invested in the bond. Your rate of return is just not really guaranteed except for the first 6 months in which you lock in the current variable rate. The rate could go up or down from 9.62% thereafter, but I suspect it’ll stay close for the next 6 months to a year because of how high inflation seems to be staying.
With inflation having been higher than expected for a while now, we’re finally seeing a decent inflation-protected rate of return with the Series I. The aim of the Series I is to give a return plus some protection against inflation on your money’s purchasing power.
So if inflation really is at 8.6%, then in theory the 9.62% Series I is giving you a real rate of return of 1%. This compares to how many banks’ high yield savings, checking, or money market accounts are on average giving 1-2% nominal interest rates. This means they’re still losing 6.5% to 7.5% against inflation.
A Series I bond is a zero coupon bond, which means you don’t get paid out any interest during the life of the bond and you invest in a bond at its face value. You get the interest paid out when you either redeem it or hold it until maturity in 30 years. When you redeem the bond, you get your original principal back plus the interest.
Also, the interest will compound upon interest. So whatever amount of interest you have earned through half a year, when the new semiannual rate kicks in you will compound on a new principal amount (original principal + interest earned to date).
As great as the Series I bond sounds, it’s not without its own limitations. You have to own it for at least a year, and then if you decide to redeem it before 5 years, there is a penalty where you give up the last 3 months’ worth of interest in which you held the bond.
Every year starting on January 1, the minimum purchase amount of $25 and the maximum purchase amount is $10,000, electronically. Paper bonds start at $50 minimum with a $5,000 maximum.
You also have flexibility on when you want to be taxed on the interest. You can pay taxes when you either redeem the bond and receive the interest some years from now, or you could pay taxes on the accrued interest each year.
As one example, lets say you invested $1000 and lets pretend the interest rate stays at 9.62% for 5 years, you would theoretically get about $583 of interest (the semiannual compounding may make it a bit different). The gross total you get back is $1583, principal and interest before you pay taxes.
While a stable interest rate of return is not likely, it is attractive because the cumulative return is 58% over 5 years or on average about 11.7% per year, which beats out the stock market’s average rate of return of 7-10% per year.
In another example, lets say you cash out of the $1000 bond exactly after the 1 year minimum holding period, how much of a return would you get up with? If the gross return is $96.20 for the year, averaging $8 per month, you would give up 3 months’ worth of interest or $24.05, giving you a net return of $72.15. This is a net yield of 7.22% before taxes. It’s still better than most bank accounts but you’re losing a little bit to inflation.
Many banks are only offering between 0.4% to 1%, while a few that seem too good to be true are offering 4-5% with some strings attached. Do your own research to validate if these offers are legit before you might go for them. But if you need the flexibility that a high yield interest account can offer, then they may be a better deal than locking up your cash for at least a year with a Series I bond.
If you’ve got some cash lying around and don’t want to invest it in stocks right now, the Series I bond may be a decent bet for up to $10K and depending on your time horizon and inflation tolerance level.
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