One of the best current offerings in the bond market – Series I Treasuries – is likely to become less attractive in November when a new interest rate is set for the popular assets.
Retail investors may want to buy the inflation-linked I-Bonds before the end of October to get the current interest rate of 9.6% for the first six months. The new rate, which will apply to bonds bought in November, is likely to be closer to 6%, Barrons Estimates based on the formula used by the US Treasury Department to calculate the semi-annual interest rate.
The main disadvantage of I-Bonds is that individuals can only buy $10,000 per year, although an additional $5,000 can be purchased with federal tax refund proceeds. And Americans who own certain companies can buy $10,000 worth of I-Bonds annually through those companies. The I-Bonds must be purchased directly from the Treasury through the TreasuryDirect program.
The I-Bond interest rate, based on the US CPI, hit a record 9.6% in late 2021 and early 2022 for bonds bought from May and lasting through the end of October due to the inflation spike. However, price increases have moderated in recent months, with the main CPI index rising 0.1% in August. Treasury has been selling I bonds since 1998.
“You should buy now,” says John Scherer, founder of Trinity Financial Planning in Middleton, Wisconsin. He says the current rate is very cheap compared to bank CDs.
I Bond rates reflect both an inflation component based on the CPI index and what the Treasury calls a fixed rate, which is now zero. The inflation rate is set twice a year in early May and November and applies to bonds purchased over the following six months. The fixed rate will also reset in November and is likely to be at or near zero.
The May interest rate of 9.6% was based on the CPI index from September 2021 to March 2022.
The Treasury uses the non-seasonally adjusted CPI index, which differs slightly from the more familiar seasonally adjusted CPI that makes headlines each month. The non-seasonally adjusted CPI increased by 4.8% from September 2021 to March 2022. That amount is multiplied by two to get the 9.6% rate applicable to bonds purchased from May through October of this year.
The new rate, to be announced in early November, is based on the CPI index from March to September. Barrons calculates that consumer prices rose 3% from March to August, according to the latest report. Assuming little change in prices in September, the new rate should be around 6%.
Investors who buy I-Bonds before November 1 will get the 9.6% rate for the first six months they hold the bonds, and then the new rate for the next six months.
“I-Bonds are definitely a great safe investment to add to your emergency funds,” says Ken Tumin, founder and editor of the Bank Deals Blog.
I-Bonds must be held for at least one year, and bonds redeemed before five years are penalized by a quarter of the interest. Tumin sees the interest penalty as modest compared to bank CDs, which typically come with prepayment penalties.
Two nice features of I-Bonds are that investors can defer paying tax on the interest payments until maturity — I-Bonds can be held for 30 years. And, like other government bonds, I-Bond rates are exempt from state and local taxes, unlike bank CDs and corporate bonds.
One risk with I-Bonds is that inflation will fall, leading to lower interest rates in the coming years. That’s entirely possible as markets are pricing in inflation of around 2.5% over the next five and 10 years. But if inflation remains stubbornly high, I Bonds will look particularly good.
Investors desiring inflation-linked bonds may also purchase Treasury Inflation-Linked Securities (TIPS), which are regularly auctioned by the Treasury and are available through TreasuryDirect and banks and brokerages. They are issued with maturities of five, 10 and 30 years. TIPS are not subject to any restrictions on purchases by individuals.
One advantage of TIPS over I Bonds is that they now offer a real or inflation-adjusted interest rate of around 1%, meaning holders receive the rate of inflation plus 1%. However, TIP prices can fluctuate and have fallen this year as real yields rose from minus 1.5% to plus 1%. The real yield on I-Bonds is now zero.
A lower-risk way to own TIPS is through ETFs like these
iShares 0-5 Year TIPS Bond ETF
(Ticker: STIP), which now has a total return of almost 10%, based on a calculation under Securities and Exchange Commission guidelines. Its real yield is around 1.5%, supplemented by the inflation adjustment.
Write to Andrew Bary at email@example.com