Article updated April 2022
Fixed income plays a vitally important role in investor portfolios, the main purpose being to diversify and be a shock-absorber against deep drawdowns in the stock market. However, due to stubbornly low interest rates, fixed income is currently not an investment where meaningful returns should be expected. Furthermore, actual inflation has spiked in the U.S. economy, causing fixed income investments to earn negative real yields. Against this backdrop is a surge in the popularity of U.S. Treasury Series I Bonds.
What are U.S. Treasury Series I Bonds?
Before we explore the usefulness of I Bonds in a portfolio, we must first understand what these securities are and how they work. Here is a rundown of I Bond characteristics:
- I Bonds are issued by the U.S. Treasury and purchased directly at https://www.treasurydirect.gov/. Note that I Bonds purchased with a tax refund are issued in paper form.
- I Bonds have a 30-year maturity with semi-annual interest compounding.
- I Bonds pay interest income, which is taxed at the federal level but is exempt from state level income tax.
- I Bonds have some liquidity restrictions, as described below.
- I Bonds have a unique combination interest rate structure, as described below.
The interest rate on I Bonds is a combination of a fixed rate and an inflation rate that together make up a composite rate. The fixed rate does not change during the life of the bond. The inflation rate adjusts semi-annually based on the Consumer Price Index for all Urban Consumers (CPI-U), causing this component of the rate to vary through the life of the bond. The rate most recently established in May 2022 will reset again in November 2022.
Why are I Bonds so Popular Now?
Effective May 2022, new I Bond issues will earn a 9.60% annualized interest rate. As we mentioned, the interest rate is a composite rate. The current fixed rate is actually 0%, but the current inflation rate is 9.60%, for a combination rate of 9.60%, making this type of bond extremely attractive. The inflation rate will adjust again in November. It should be noted that this rate is the highest since May 2000.
What are the limitations of I Bonds?
The main restriction with I Bonds is that investors are limited to $10,000 annual purchases. This amount can be increased by an additional $5,000 if purchased with a federal income tax refund. I Bonds must be owned for one year before they can be cashed, and if you sell them before a five-year holding period, then there is a forfeiture of three months of interest. After five years, I Bonds can be redeemed at current value. I Bonds must be purchased directly from the U.S. Treasury and cannot be owned in a Roth IRA.
Main Takeaways
Fixed income investments remain an essential part of an investment portfolio, but current low rates and high inflation present a challenge. Compared to conventional fixed income, I Bonds have a lot of appeal, and for good reason, making them an excellent investment idea. However, purchase restrictions don’t allow for them to be a meaningful portion of larger portfolios. In a low interest rate and high inflationary environment, I Bonds can be quite helpful in an attempt to boost returns from fixed income. Because they are government issued, they fit nicely into the safe corner of an investment plan. For more information about I Bonds, please contact our team.
This is based upon publicly available information and is provided for general information and educational purposes only. The information contained herein has been compiled from data considered to be reliable. The information in these materials, including interest rates may change at any time and without notice.
