What the Heck is an “I Bond” and Should You Buy One?

What the Heck is an “I Bond” and Should You Buy One?

May 28, 2023

I’ve been asked a lot lately about what an I Bond actually is, and how worthwhile they are. Many pundits in the media will tell you purchasing an I Bond is a “no-lose” investment strategy that everyone (and their mother) should implement. I don’t recommend investing money in anything you don’t understand, so I feel a more nuanced look at this strategy is in order.

What are these strange critters called I Bonds?

First, the “I” in “I Bond” does not stand for “idiot-proof”. It stands for “inflation”. And we have talked a lot lately about what has been happening with inflation (Hint: it is high).

The US Treasury created 30-year I Bonds in 1998. The idea was to give investors a tool to hedge against inflation. I Bonds are backed by the federal government, so unless the government defaults on its debt, the interest rate on I Bonds appears low risk.

I Bonds interest rate is a combination of two rates called the composite interest rate. It is calculated based on a fixed interest rate (which never changes) and an inflation rate (which is tied to inflation). The interest structure is what makes I Bonds quite unique.

What are the benefits of I Bonds?

  • I Bonds are an Inflation hedge. Inflation has been going up and has driven the variable component of the rate to 9.62% for May 2022 through October 2022. This rate is in effect if you purchase prior to November (when the variable rate will again be reset).
  • The return is attractive for an investment backed by the US government.
  • I Bonds are exempt from state taxes (but not federal). They may be tax exempt if used for qualified higher education.
  • The I Bond return can’t go below zero.

What are a few caveats of I Bonds?

  • Your cash is locked up for a year (you cannot redeem for 12 months), and if you redeem after 12 months (and before 5 years), you forfeit 3 months interest, which will affect your return.
  • If inflation drops, your return drops. Remember the 9.62% is the annualized rate, reset every 6 months, and so it will reset again in November. So, if inflation is reset to 6.0% in November (and you cash out next year after holding 12 months) your net interest rate will likely be below 6.0% (after paying the 3-month penalty and before taxes).
  • The maximum purchase amount per person is relatively low and it can only be bought through the government. You will need to think about if it is worth your time and the “hassle” (and will need to create a separate account for each).
  • Opportunity costs. If you have excess cash, can you potentially beat inflation (in aggregate) by investing in other assets (real estate, stocks, commodities)?

Does my portfolio already have something similar?

You can also incorporate Treasury Inflation-Protected Securities, or TIPS, to provide protection against inflation. Here is a great comparison tool on TreasuryDirect explaining the difference.

Truman Wealth portfolios contain Treasury Inflation-Protected Securities, or TIPS, to provide protection against inflation. With TIPS, there is no limit on the amount that can be purchased, it is easy to incorporate into a portfolio and provides similar protection.

The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.

How do I purchase (and redeem) I Bonds?

There are actually only two ways to purchase I Bonds:

There are redemption details for each one here.

You cannot resell them and you must cash them out directly with the US government. Electronic I Bonds can be redeemed directly on the Treasury Direct website and the paper I Bonds can be cashed in at a local bank.

A word of warning: Since the Treasury website links to your bank account, make sure that you choose one that you are going to use forever. Changing a bank account once you have established an account on Treasury Direct can be an onerous process.

What’s the next step?

Are I Bonds right for you? If you want to take a proactive approach and talk it over with a professional, please reach out and our team at Truman Wealth would be happy to learn more about your specific needs.

Special Note: Truman Wealth Advisors can’t purchase I Bonds on your behalf, and you can’t buy them in a traditional brokerage account. However, we’re happy to provide some points to ponder if you are considering I Bonds as part of your overall investment strategy.