I Savings Bonds - Should You Buy Some?

Recommendation

There is a small advantage to buying I Savings Bonds vs. keeping cash in a reasonable Money Market fund for the short term (next 1-2 years). The advantage is roughly $200 per person (~2% on $10K).

Investing in I Savings Bond makes sense for those looking to gain an advantage over cash of ~$200 per person per year.

The downside of the I Savings Bond is that one locks up capital for at least one year, and one needs to go through the administrative hassle of creating an account with Treasury Direct (cannot hold I Savings Bonds in normal brokerage accounts).

I am not investing in I Savings Bonds on behalf of my family, as I don’t feel like the effort of setting up a new account, or the illiquidity associated with the bond, are compensated appropriately.

Details

• One can buy I Savings Bonds from TreasuryDirect.com - a website that allows one to establish a “brokerage account” with the US Government.

  • One cannot buy these bonds from other brokerage accounts.

• Purchases are limited to $10K per person.

• The money one spends on I Bonds is locked up for a minimum of 1 year. After one year, one can redeem the I Bond to get your investment back, plus the accrued interest one has received.

  • Redemptions in the first five years entail a one-quarter interest penalty.

• These bonds do not provide current cash flow. Any interest earned is added to the principal of the bond and is then available when one redeems.

• These are variable rate bonds that depend on CPI. The quoted rate is the annual interest rate for the first six months. A rate quote of “9.6%” means that the bond will accrue interest of 9.6% /2 = 4.8% over the first six months.

  • The current rate of 9.6% consists of:

    • CPI Annual Rate of 9.6% (or semi-annual rate of 4.8%)

    • Fixed Rate of 0.0%

  •  Future interest rates depend on a fixed rate of 0% plus the measurement of CPI for the preceding period.

  • I Savings Bonds never lose value, so if the CPI rate is negative for a measurement period, the bond will maintain its current value and not decrease in value. In mathematical terms:

    • Max(Fixed Rate + CPI, 0)

Example: You spend $10K on an I Savings Bond today (August 29, 2022).

• The “annual interest rate” of this bond is 9.6%. However, this interest rate is only good for the next six months. After six months, it will get recalculated based upon CPI.

• On February 29, 2023 - the value of your bond will increase from $10,000 to $10,480 (4.8% semi-annual interest).

  • The interest rate for the next six months will be determined on November 1, 2022.

  • The market expects this interest rate to be 6.7% (or 3.37% semi-annual interest).

• On August 29, 2023, assuming the projection is correct, your bond will increase in value from $10,480 to ~$10,833.

  • If one decided to cash out at that point in time, one would pay a 3 month penalty and receive back $10,657.

  • The $657 gain would be taxed at Federal Income tax rates. At the top marginal rate, this would be 37% and post-tax a client would take home $413 or would have a ~4.1% post-tax return.

  • In comparison, keeping money in a Fidelity Money Market is likely to give a 3.1% pre-tax return and 1.9% post-tax return.

  • The difference is about ~$210 per $10K invested post-tax.

• If held for an additional four years (to avoid the interest penalty), and using market expectations of 2.8% inflation, one would expect their bond value to increase from $10,833 to $12,102.

  • This would be a 3.9% pre-tax annualized return.

  • After 37% taxes, this would be a 2.5% post-tax annualized return.