Series I savings bonds: Inflation protection from Uncle Sam

If you want hefty investment returns, you usually have to take on a fair amount of risk. But as inflation raged in the early 2020s, a high return/low risk savings vehicle rose to prominence: Series I savings bonds. Although I bonds won’t solve all your inflation woes, they’re one way to help protect your portfolio from the pain of rising prices.

Traditional high-return investments include stocks with lofty dividend yields, as well as so-called junk bonds. The yield on a junk bond is high for a reason: There’s a decent chance the issuer could cancel future payments or even default, leaving you in the red. Basically, you’re being paid extra to take on more risk.

Series I savings bonds—sometimes called TreasuryDirect I bonds or inflation-protected bonds—stand out from that sometimes motley mix by offering competitive yields, but with the backing of the federal government. The U.S. has never defaulted on debt, so you’re assured of getting back every cent of the money you invest in a Series I savings bond. And along the way you’ll be paid an attractive interest rate—at least one that keeps up with inflation.

Eye-popping interest, but not forever

What kind of interest? Well, the initial I bond rate rose to 9.62% in mid-2022 as inflation hit 40-year highs. No, that’s not a misprint, even if it seems like the kind of yield you’d normally get from a desperate company on the brink of default. Why was the yield so high?

• I bonds are regularly adjusted for inflation.
• The rate is calculated twice a year and based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy.
• When inflation goes haywire as it did in 2022, the interest rate goes up, making I bonds a more powerful investment tool.

The 9.62% rate sounds impressive, but it only applied to the first six months. Subsequent rate updates dropped the annualized rate to 6.89% and then 4.3%, but the current annualized rate—for I bonds purchased through April 2026—is 4.03%.

That’s the initial rate, guaranteed for six months. After that, your yields will continue to adjust for as long as you own the bond.

So maybe you’re thinking of rushing to put your entire portfolio into I bonds to get that low-risk/high-return yield. That could be an option as long as your portfolio is $10,000 or less, although it’s probably best to work some asset allocation into your planning. If you have more than $10,000 to invest, you’ll need to put the rest somewhere else—annual I bond purchases are capped at $10,000 per person.

I bonds and other savings bonds seemed kind of vanilla for many years, because they tended to have very low interest rates. With inflation under 3% for decades leading into 2020, savings bonds just couldn’t offer the kind of yields that looked good in comparison to, say, technology stocks growing 20% a year.

All that changed after the COVID-19 pandemic. Inflation surged worldwide amid worker shortages and supply chain hiccups. The Consumer Price Index (CPI) rose to 9.1% year-over-year for U.S. consumer prices by June 2022, a level last seen in late 1981, and remained above 8% into the fall of 2022. With an accompanying sharp loss in stock prices, I bonds and their robust inflation-adjusted yields suddenly looked more enticing to many investors.

How to buy a Series I Savings Bond

You can only buy a Series I savings bond directly from the U.S. government. It works like this:

• Set up an electronic account at the Treasury Department. You’ll need to provide some personal information, as you would when setting up any other financial account.
• Give the Treasury Department access to your bank account by providing the bank’s routing number (found at the bottom left corner of your personal checks) and your account number at the bank (see the center bottom of your check).
• Tell the Treasury Department how much you want to invest. The minimum is $25, and an individual can invest up to $10,000 in a given year. Your spouse or partner can also buy an I bond, but they’ll need to set up their own account.
• The Treasury Department electronically moves the money from your bank account into the account you set up at the Treasury Department.
• Collect interest at the stated interest rate—but that rate won’t last. It’s only good for the first six months you own the bond. The government adjusts the rate every May 1 and November 1.

After six months, the interest you’ve earned is added to the principal value, and interest after that is earned on the new principal, but at whatever new rate the government chooses. You can keep the bond for up to 30 years.

If inflation drops meaningfully in the six months after you purchase your I bond, you’ll be stuck with the bond and its lower rate for at least another six months, because you can’t cash out before owning the bond for a year. And if you cash out before owning it for at least five years, you’ll lose your last three months of interest.

Series I savings bonds cannot be purchased through a 401(k) plan, Individual Retirement Account (IRA), or other tax-advantaged account. They’re part of your regular taxable savings. Interest on I bonds is exempt from state and local taxes, and federal taxes can be deferred until you redeem the bonds or they reach maturity. You can choose to report interest annually, but most investors defer payment until the end.

The bottom line

I bonds are a relatively risk-free investment that pay a competitive interest rate, especially in a rising-rate environment. The rate rises and falls—and sometimes lags other fixed-income securities. Still, it could be worth parking some of your money in I bonds to keep up with rising consumer prices. Before deciding, consider the pros and cons of inflation-linked securities.

References

• I Bonds | treasurydirect.gov