I get a lot of questions about money. These questions usually vary depending on the person asking the question and their needs, but I get one question more often than any other: “What is a safe investment with a high return?”
I haven’t had an answer to that question for the past decade or so. Savings accounts and certificates of deposit are safe, but no longer an attractive investment. Interest rates have remained shockingly low since the Great Recession of 2008/2009. This is by design. The government doesn’t want you to park your money in a savings account. They want the money to circulate in the economy.
In the long term, the stock market offers excellent returns. But when people ask about “safe” investments, they want to avoid short-term volatility, which means stocks are out of the question. (And things like Bitcoin and precious metals are even more possible!)
Today, however, while catching up on my blog reading, I stumbled upon a link from Michael Kitces’ weekly financial planner summary. The story he told blew my mind. In an article in the Wall Street Journal, Jason Zweig explains the safe, high-yielding trade that is hiding in public. (This article is behind a paywall.) That safe, high-return trade? US Treasury Bonds Series I.
These inflation-adjusted bonds currently yield 3.54% annually!
Economists say there is no free lunch, but I-bonds offer a U.S. government guarantee that you will get back your original capital plus any increases in the official cost of living. The only catch is this isn’t an all-you-can-eat buffet: the maximum purchase is $ 10,000 per year per account holder (unless you opt for a tax refund in the form of an I-bond).
Ironically, the less you have to earn and invest, the more powerful a Tool I Bonds is.
Unfamiliar with I Bonds, I spent a couple of hours reading about it today. I think I’ll start adding them to my investment portfolio. You may also want to. Let me share what I learned.
The basics of I-bonds
Series I savings bonds (or simply “I-Bonds”) are inflation-linked bonds with a floating rate. This variable interest rate consists of two components.
- A fixed price. On the first business day in May and on the first business day in November, the US Treasury Department adjusts this fixed rate for new bonds. But once you buy a Series I bond, that fixed rate never changes. If the fixed portion of your I-bond is 2.10% when you buy it, it will remain 2.10% for 30 years (or until you sell it).
- A floating rate that is linked to inflation. This rate will also be adjusted in early May and November. It is based on changes in the consumer price index. Currently, the “semi-annual inflation rate” (as it is officially called) is 1.77%, which equates to an annual rate of 3.54%.
The fixed and variable interest components are added to get the current compound interest rate. Since inflation can go negative (also known as deflation), the floating rate can also go negative. In this case, the current yield on your I Bonds can fall below the fixed interest rate. However, the interest on these bonds can never go below zero. You can never lose value.
Interest rates every six months. I Bonds are exempt from state and local taxes, but are subject to federal income tax on repayment.
Does it all sound complicated? It is not really.
When you buy a Series I bond, you set your fixed rate. The floating rate is then adjusted to inflation every six months.
The fixed interest rate for Series I savings bonds is currently zero. In fact, all Series I bonds issued since May 2008 have had a fixed interest rate of less than one percent. Then why should you add them to your portfolio? Because despite the low fixed rate, these things still earn savings accounts and certificates of deposit.
However, the cash you put in these bonds is much less liquid than the money you put in the bank.
- You must hold the bond for at least a year. There is absolutely no way you can repay a Series I bond before it is twelve months old.
- You can repay the bond after a year. However, if you haven’t held the bond for at least five years, you will lose the last three months of accrued interest.
There are a couple of other cons that you need to be aware of. First, you can only buy I Bonds electronically from Treasury Direct. (This is an official US government website, so it’s safe. Or should be.) Second, you’re only allowed to buy $ 10,000 of I-bonds each year.
Did I say “just”? I lied. Somehow. You can also buy I Bonds with your income tax refund. That way, you can get up to $ 5,000 more in I-bonds each year. And bonds bought this way are paper bonds, not electronic ones.
There are other minor things you might want to know about these investment vehicles. For more information, see the Official Series I Savings Bonds FAQ (And you might also like this table comparing I bonds to TIPS, inflation-linked Treasury securities.)
I bonds in numbers
Because I’m a money nerd – and because I was curious – I created a table that documents the historical returns on Series I bonds since they were released in September 1998. (This is based on the official table from Treasury Direct, but I’ve made it nicer and easier to update in the future.)
This is a wide table so it cannot be read here on this screen. You want to open the picture in a new tab. (If you click the image, it should be done for you.) Even then, you may have to manually resize the image to read it.
So read this table.
- Each row represents the Series I bond interest rate returned for data in this area. For example, the line “05/08 – 10/08” shows how the interest rate on bonds issued between May and October 2008 changed. The first number in each row (the “Fixed Rate” in the green column) shows the fixed rate for the bonds issued during that period. For the bonds “05/08 – 10/08” this fixed interest rate was 0.00%.
- Each column tracks semi-annual changes in interest rates. The Treasury will adjust rates on (or shortly thereafter) May 1st and November 1st. The top row of each column shows the official inflation rate, which is used to calculate total bond yields. So you can see that the “May-08” column shows that the semi-annual inflation rate was 2.42% (which is an annual inflation rate of 4.84%), and the rest of the column shows effective rates on various bonds.
- I also tried compiling historical data on average certificate of deposit rates. However, I have not found a source that I trust and love for this information, so I am open to recommendations. (I’d also like to find a source for historical savings account information. I’ve been searching for years and have never found anything I like.)
If you look at this table, you can see that I-bonds don’t always outperform five-year certificates of deposit – but they usually do. And there have been a couple of occasions when even a year-long CD gave better returns for a few months.
The bottom line
I have never bought a savings bond before. That’s going to change.
I like the idea of using I Bonds as a vehicle for medium-term investments – saving for a home, saving for college, etc. If your time horizon is longer than five years but shorter than, say, fifteen years, these are an attractive option, especially if it is money that you cannot afford to lose. Right now I like them better than a savings account or a CD!
For longer time horizons and for money that allows you to take more risks, it is better to invest in index funds. Series I bonds are not going to make as much as stocks in the long run. At least not based on historical averages. But that is not the point. These bonds are not meant to grow your nest egg. You should keep your nest egg safe.
Even if these don’t suit you right now, keep an eye on Series I bonds to see where their fixed rates are going. If they sneak into the three percent range (like 20+ years ago), they’re great business.