Last November, we encouraged readers and clients to take advantage of the yield on Series I Savings Bonds (ibonds). These bonds were yielding 7.12% at the time and the yield just went through its semiannual reset. The Treasury recently announced new rates on the ibonds of 9.68%, effective from May 1, 2022-November 1, 2022. This is an extremely attractive rate that most investors should consider taking advantage of.
What are Series I Savings Bonds?
Series I Savings bonds are government savings bonds that earn interest based on combining a fixed rate and an inflation rate to get the composite rate. The fixed rate does not change for the life of the bond but the inflation rate is reset every six months. There are only two ways to buy these bonds, through the TreasuryDirect.gov website or through your tax return by including an IRS Form 8888 when you file.
Individuals can purchase up to $10,000 worth of these bonds through Treasury Direct and up to $5,000 per year through their tax return ($15,000 total). These bonds have a 30 year maturity and the interest rate earned resets every 6 months. They will never yield less than 0% but they can (and have in the past) yield 0% depending on the rate of inflation.
Because the fixed rate on these bonds is currently 0%, the interest rate the bond pays is exclusively dependent on inflation, as measured by the Consumer Price Index for all Urban Consumers (CPI-U).
The composite equation
To figure the bond’s yield the Treasury uses the following equation:
Composite rate = [fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)]
For example, the CPI-U increased from 274.310 in September 2021 to 287.504 in March 2022, a six-month change of 4.81%. Therefore, we plug the fixed rate (0.00%) and the semiannual inflation rate (4.81%) into the equation:[0.0000 + (2 x 0.0481) + (0.0000 x 0.0481)] = [0.0000 + 0.0968 + 0.0000000] = 0.968 = 9.68%.
The current interest rate is 9.68%. But, this rate can and likely will change in six months when the semiannual inflation rate is recalculated. The next change will occur in November 2022 and will be based on the semiannual inflation rate from March 2022-September 2022. Importantly, the 9.68% yield applies for six months from the date of your purchase, for any ibonds purchased by October 31, 2022. So if you buy an ibond in September, you’ll still earn 9.68% for six months, even if the rate resets to 0% in November (you’d then earn 0% after your initial six months post purchase timeline is up).
So is this a good investment?
If you have not purchased any ibonds in 2022, you can purchase up to $10,000 (yearly limit). This is an individual limit, so you can buy $20,000 as a couple. You can also purchase ibonds for your children or through your business (provided you have an EIN). You can purchase them all at once or periodically, so long as you don’t go over the $10,000 limit. You are guaranteed to earn 9.68% for at least six months as long as you buy ibonds before October 31, 2022.
The current 9.68% yield is very likely to change in six months time. And if inflation has moderated by then, the interest rate on the bond is going to be lower. In order to maintain the same 9.68% interest rate during the next reset in May 2022, CPI-U would have to come in at 301 in March 2022. Honestly, that would probably not be good for stocks because it would mean inflation has soared even higher. But, that’s all the more reason to purchase some ibonds.
Here is what the Series I Savings bond interest rate will look like in May based on a range of different CPI-U outcomes (mouse over chart for figures, chart assumes base fixed rate does not change):
The bond will never yield less than 0% (the Treasury keeps a floor at 0%), but if the change in CPI-U is negative during the Sep 2021-Mar 2022 period, the interest rate will fall to 0%. In fact, even if inflation has risen another 1% during the period, the interest rate on the Series I Savings bond will fall to about 2%. Inflation, as measured by CPI-U, will need to rise 4.69% during the period for ibond’s to maintain their current 9.68% yield.
Keys to consider
There are few key considerations before buying these bonds. First, keep in mind that the interest rate is reset semiannually based on the change in CPI-U. Therefore, the current yield of 9.68% is only 1/2 of the annualized yield. The true annualized yield depends on where the next yield is set in November 2022. If that rate is set at 4%, and the bond is held for 12 months, the annualized yield would be around 6.84% [(9.68% x 1/2) + (4% x 1/2)].
Remember, if CPI-U comes in at 287.50 (the March reading) or lower in November 2022, the Series I Savings bond interest rate is going to be 0% (refer to the equation and chart referenced in earlier paragraphs). In that case the annualized rate would be 4.84% [(9.68 x 1/2) + (0% x 1/2)]. The change in inflation is the driving force of the bond’s yield.
The Series I Savings bonds can only be redeemed starting 12 months after you bought them. And if you cash the bond within five years of buying it, you lose the last three months of interest. Because these are essentially risk-free vehicles you can still view them as an effective way to generate some extra savings on some spare cash.
Even if we assumed the rate falls back to 0% in November 2022, and you redeemed on the 12th month, you would still have earned an annualized rate of 4.84%. That’s because you capture half of the 9.68% rate in the first six months. Then, you earn 0% for the next six months. Because you redeemed within five years, you lose the last 3 months of interest, but that is 3 months of 0%. When compared to the leading 12-month CD rates, which are currently between 1.25-1.50%, this Series I Savings bond is an excellent alternative. In addition, interest on these bonds is exempt from state taxes, unlike CDs which are taxed at the state level.
Should you buy these?
The Series I Savings bonds, currently yielding 9.68%, are a great investment if you are looking to earn interest well above what’s currently offered by the banks. The $10,000 purchase limit may dampen the appeal a little bit, but that’s still $10,000 you can effectively lock in a 4.84% return on, on a security backed by the US Treasury. A married couple can get $20,000 worth of these bonds now, and earn at least $968 in interest over the next 12 months. That’s money that can go towards a car payment, a vacation, college savings, etc.
Basically, our view is that these bonds make for great savings alternatives for investors with a short-term time frame. If you are viewing these as a long-term investment vehicle, they may not be as attractive. That’s because of the risk that we are in a very high inflationary environment right now, and if that recedes in 2022-2023, these bonds could realistically yield 0%-1% for an entire year.
How to buy Series I Savings bonds
If you do want to pull the trigger and invest, you’ll have to go through the TreasuryDirect.gov directly. These are not something you can buy through your brokerage account. To get started, create an account on the TreasuryDirect website. You will need your personal information as well as your bank account information. After you fill everything out, you will receive an account number to your email. You’ll use that to login. After you login for the first time, you’ll see a tab to “BuyDirect” where you can purchase the Series I Savings, as shown in the screenshot below:
To recap, Series I Savings bonds are a type of savings bond backed by the US Treasury. They are extremely safe and are currently yielding 9.68%. This is a rate that we think investors should take advantage of if they have the means to do so. While the rate will change in the future, the 12 month return profile is far more attractive than any comparable alternatives. Depending on the change in inflation, these bonds may yield more or less in the future.