By: Tim Fortier — November 17, 2021
7.12% from Government Bonds? You Bet!
As inflation rates increase, so do the costs of everyday goods. This is especially harmful if you live on a fixed income.
With central banks all over the world keeping interest rates artificially low, it is extremely difficult for investors who want to invest for income.
In years past, many investors used the standard approach and bought bank CDs, U.S. Treasuries, and municipal bonds. But that approach provides virtually no value to investors today.
According to Bankrate, the best two-year CD rate yields 0.70%, and the best five-year rate yields just 1.00%. When you consider the recently reported 12-month inflation rate is 6.2%, it easy to see why bank CDs are a non-starter.
Extending maturities, the five-year U.S. Government treasury bonds currently pay 1.13% and 10-year bonds deliver 1.38%.
Munis are not much better. Bloomberg reports that the 30-year municipal benchmark yield is 1.63%. Even considering the taxable equivalent yield is 2.26%, that's still negative when adding inflation into the equation.
And don't forget this. The longer the maturity of the bond, the greater the interim risk to the principal should interest rates begin to rise. With today's low rates, even a 1% increase in interest rates could drag investors underwater on any long-duration bonds for a good long while.
For many investors, the lack of any real yield has forced them to take greater risks than they normally would. Investors have chased high yield bonds to historic extremes, so much so that the spread between junk bonds and treasuries is at record lows.
And of course, some investors have put their money into stocks where, of course, nothing is certain.
Now I have good news and bad news.
The good news is that there is an attractive option available to everyone. The bad news is that you are limited by how much you can invest.
I-bonds, issued by the U.S. Treasury, is the floating-rate equivalent of EE Savings Bonds. The interest rate is reset every six months based on the rate of change in CPI-U calculated by the Labor Department's Bureau of Labor Statistics.
Technically, there is both a fixed rate and one set by the current inflation rate as measured by the Consumer Price Index for all Urban Consumers (CPI-U).
The current fixed rate is 0.00% so all that matters is the inflation rate. The fixed rate for I bonds is announced on the first business day of May and on the first business day in November. That fixed rate then applies to all I bonds issued during the next six months,
The inflation rate was just adjusted on Nov. 1 at 7.12%. This rate will again be reset in May 2022. Unlike the fixed-rate which does not change for the life of the bond, the inflation rate can and usually does change every six months.
Interest is federally taxable but is state exempt.
The I-Bonds accrue interest at six-month intervals. They will continue to accrue interest for up to 30 years. Interest may be completely tax-exempt if used for qualifying education expenses.
Buying and Selling
You need to open a Treasury Direct account to buy them.
In a calendar year, you can acquire:
- up to $10,000 in electronic I bonds in Treasury Direct.
- up to $5,000 in paper I bonds using your federal income tax refund.
Thus, it's possible to buy up to a maximum of $15,000 per calendar year, per individual. A couple with two children could purchase a total of $40,000 through the Treasury Direct program by using separate registrations.
Since they are in the savings-bond family, the I-Bonds offer no market-based liquidity. Buyers must hold for at least a year. After that, in years one through five, you may cash out with a three-month interest penalty.
For investors looking for a competitive interest rate that is also meant to keep pace with inflation, look no further than I bonds.
Enjoy your day,
Tim Fortier, Editor