Series I bonds have been a popular and attractive investment in recent years as inflation rose to multi-decade highs. The bonds adjust their interest rates to take inflation into account, allowing investors to offset rising prices while offering the safety of a government bond. But now that inflation is easing, is it time to think about selling your Series I bonds?
Here are some important things to consider if you’re considering investing in I-bonds today.
Are Series I Bonds an Attractive Investment Now?
Because interest rates on Series I bonds are based on inflation, interest rates can fluctuate dramatically from time to time. The bonds pay interest of 5.27 percent for a full six months for all bonds opened and registered before April 30, 2024. That is of course considerably less than the 9.62 percent and 6.89 percent that investors could get last year.
So no one will argue that interest rates are better now than in the recent past, but does it make sense to hold your I-bonds today or even buy more of them? Here are three important things to consider when thinking about what to do with your I bonds.
1. You’re fighting the Federal Reserve
The Federal Reserve has worked furiously to stem inflation over the past two years, with some success. While inflation is below mid-2023 highs, it remains stubbornly high despite the central bank’s strong attack. So the high returns of I-bond investors depend on the Fed failing, or in other words, them fighting the Fed. There is an old saying among investors: “Don’t fight the Fed.” The central bank has virtually unlimited resources to do whatever it wants.
“Officials have been raising interest rates to quell the flames of inflation from their key ingredients: demand for goods and services,” said Sarah Foster, Bankrate’s U.S. economy reporter. “And they’ve made great progress. Inflation has slowed from a staggering 9.1 percent in June 2023 to the recent 3.7 percent in August.”
If the Fed continues to be successful, it could reduce inflation even further, resulting in falling yields on future I-bonds. But if the Fed becomes too aggressive, it could push the economy into a recession, meaning inflation will likely fall below the Fed’s long-term target of 2 percent. Bankrate’s second-quarter survey shows that the chance of a recession in July 2024 is 59 percent.
Recession or not, the Fed continues to work to reduce inflation, and it is uncertain how long this will last. Foster says the nation’s central bankers don’t see inflation reaching the Fed’s 2 percent target until 2026. Whether that happens remains to be seen, but either way, investors in Series I bonds are fighting the Fed, and the Fed’s actions have enormous consequences. effects.
To get a higher interest rate on your I-bonds, you’re betting on higher inflation, despite the water hose the Fed unleashes on the flames of inflation.
2. I-bonds have important (and costly) time limits
Series I bonds have a number of important time periods that investors should keep in mind, both of which can affect when the bonds can be redeemed:
- Series I bonds cannot be cashed in for the first twelve months you own them.
- Owners of Series I bonds will pay a penalty of the last three months of interest if they cash in the bonds before owning them for five years.
So if you’re considering buying I-bonds today, you need to consider the trajectory of inflation over the next few years because you’ll own the bond for at least that period. If that doesn’t make sense, consider some alternatives, perhaps some low-risk investments.
Those who have held the bonds longer may want to do some math to figure out how to proceed. If interest rates drop, so will the penalty for cashing out your bond. So it may make sense to wait longer than you would otherwise to avoid the fine. At rates of 9.62 percent, the fine was much higher than at current rates, so it may make sense to bail if you have a better option.
Those who have held the bonds for five years obviously face no such penalties and can simply make their decision based on what the various alternatives are for their money. With new rates announced in May and November, it may be worth waiting to see what the new rate is.
And even if rates today are better for something else — like the best CD rate — it might make sense to hold on to your I bonds if, say, you still have a year to avoid the penalty. The path of inflation is somewhat uncertain, and you may ultimately be better off if you spend a little more time holding your I-bonds.
3. Other government bonds may be better
If you’re looking for the lower risk of U.S. Treasury bonds, you may have some alternatives to Series I bonds today in the form of other government bonds, namely Treasury bonds. In fact, these bonds have the potential to earn higher returns overall, if the Fed ultimately manages to lower inflation or even if its actions push the economy into recession and overall interest rates fall.
For example, the 10-year Treasury bond now yields 4.79 percent, meaning you’ll receive that rate semiannually for the next 10 years. That’s not as good as the I-bond yield of 5.27 percent, but the Treasury Department could provide a significant benefit. Unlike I-bonds, where your principal is never at risk and does not fluctuate in value, the price of government bonds will fluctuate over time. If interest rates fall in the future, government bonds will rise in value, giving you two ways to make money.
Like I bonds, the interest on state and local taxes is not subject to state and local taxes, but unlike them, you can sell government bonds at any time, even though you may get more – or less – than you paid .
If prevailing interest rates continue to rise, government bonds will obviously decline in value for a while, although you will still get the interest rate you signed up for over the life of the bond. But any temporary decline in the bond’s value will be erased as its maturity approaches. If you don’t want this main risk but still want a higher rate, a top-tier CD may be your best choice.
“Rates could stay higher for longer, or at least higher than consumers have been used to for the past 20 years,” Foster warns.
In short
With the Fed seemingly getting inflation under control, investors should not expect I-bond yields to return to 2023 levels. However, I-bond yields could still remain near current levels if the Fed continues to struggle to contain inflation. And if the Fed goes too far, inflation could drop significantly, lowering yields on I-bonds when they come up for semiannual renewal.
