I didn’t buy a bond backed by the full faith and credit of the US Government even though it is yielding 7.12% in a world where many other government bonds are yielding under 2%.
That’s what I am going to answer today.
Economically, it makes sense to buy I Bonds. I have cash I don’t plan to use for the next year, and I would likely earn a higher rate of return than keeping it in my savings account. Why give up the incremental return?
I’m not trying to optimize every financial decision. I also want to enjoy life and spend less time on certain financial choices.
Before I explain why I didn’t buy I Bonds, let’s explore how I Bonds work and then at the end, I’ll give you a framework to help you choose whether to invest in I Bonds.
What are I Bonds?
Series I savings bonds are bonds backed by the full faith and credit of the US Government. In other words, they are less risky bonds.
How They Work
I Bonds earn interest for 30 years based on two rates:
- Fixed rate
- Inflation rate
The fixed-rate does not change for the 30 years of owning the bond. Currently, the fixed rate is 0%.
The inflation rate can change every six months. Currently, the semiannual inflation rate is 3.56%, which is how you arrive at 7.12% on an annual basis.
The inflation rate adjusts based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy.
The current 7.12% interest rate applies for the first six months you own the bond and then adjusts. Interest is compounded semiannually.
The current 7.12% interest on I Bonds started in November and can be purchased through April 2022. The 0% fixed rate will stay the same for the life of the bond that was purchased, but the inflation component will change.
If inflation is higher than the last time they measured it, I Bonds will have a higher interest rate.
If inflation is less than the last time they measured it, the inflation component will go down on the bond and the interest rate will also go down.
What this means is that the 7.12% is good for the first six months of owning the bond, but after that, it adjusts. If inflation is low enough, the bond could yield 0% for the following six months.
Even if that happened, 3.56% for a year in a less risky bond is still a good rate of return.
People can report the interest every year from the bond or wait to report all the interest for the year in which the first of these events occur:
- You cash the bond
- You give up ownership and the bond is reissued
- The bond matures
If you choose to report the interest every year, you must continue doing that for all savings bonds in the future.
I Bonds are subject to federal income tax, but not state or local income tax.
How They Are Bought and Redeemed
I Bonds can be bought using the TreasuryDirect. You can also buy them in paper form using your federal income tax refund.
Each person can buy up to $10,000 per year through the TreasuryDirect and $5,000 in paper I Bonds using your federal income tax refund. This means you could buy up to $15,000 in 2022. If you are a married couple filing jointly, you could buy $25,000 worth of I Bonds. Each of you could buy $10,000 and then you could use $5,000 to buy paper I Bonds if you had a big enough refund. If you wanted to do this, you may want to make a large estimated tax payment so that it results in a larger fund to reach the maximum.
Please keep in mind the 7.12% yield applies through April 2022. If you purchase after that date, the interest rate you earn may change because the inflation component of bonds purchased after April 2022 may change.
The bonds are not as liquid as some other bonds. The first time you can redeem the bond and receive the current value is after they are a year old. If you cash them before they are five years old, you will lose the last three months of interest. For example, if you bought an I Bond and redeemed it after it was a year old, you would give up the interest you earned in months 10, 11, and 12.
Any time after five years, you can receive the current value of the bond without losing any interest.
My Reasoning for Not Buying I Bonds
The interest rate on I Bonds is very attractive right now. Economically, it makes sense to buy I Bonds because I have cash that I don’t plan on using in the next year.
The problem is I don’t want to track another account.
If I earned 3.56% over the year, that is far better than the 0.5% current interest rate on my Ally account. This is assuming the bond earns 0% after the current 7.12% interest rate. I don’t know what the interest rate will be in the second six-month period, but 0% is a very conservative estimate.
While the actual rate sounds attractive, the actual dollar benefit over holding cash in Ally assuming the bonds earn 0% in the second sixth month period is $306. This assumes only buying $10,000 worth and not bothering with the paper I Bonds. I could buy the paper I Bonds and then convert them to an electronic format, but again, it’s more time-consuming than I want it to be.
It’s a good chunk of money, but it’s not enough to move the needle for my personal financial situation. I’d rather spend the time I would have used buying the bonds working on my business or enjoying life.
I’m choosing not to optimize every financial decision, and that’s okay. It’s my personal choice.
The key is that I actively made a choice not to buy them. It would be one thing if I didn’t spend any time thinking about it and chose the default route because, in that situation, I may miss opportunities worth far more to me.
I know what I am giving up ($306), and I am okay with it.
Should You Buy I Bonds?
Maybe. It depends on your personal situation.
Do you have extra cash you don’t need in the next year? That might be a good reason to buy them.
If there is a chance you need the cash in the next year, I personally wouldn’t buy the bonds because you can’t redeem them in the first year. After the first year, giving up the last three months of interest isn’t bad, especially if the current interest is 0% or a low interest rate. In the case of 0%, you would not be giving up any interest.
The biggest downside is the maximum amount you can buy. Given how little you can buy, is the extra effort worth the additional interest?
For some people, yes. For others, no.
Whenever I am making a financial decision, I also need to factor in the time and energy required to accomplish it. Does it move the needle on the financial plan? Could time be better spent enjoying life and spending time with family and friends? How does it complicate things for me or my heirs in the future?
In this case, it was one other investment to track over time, and I generally prefer simplicity with fewer accounts.
Maybe you are okay with multiple accounts and things being less simple. I’ve personally made the decision to simplify in certain areas because I have other parts of my financial life that are complicated.
The unfortunate aspect of I Bonds right now is that people who have $10,000 available likely won’t see a significant increase to their net worth (i.e. it won’t move the needle), and the people who would benefit greatly from the higher interest may not have the $10,000 to invest in I Bonds.
For instance, if you have a $500,000 net worth, $300+ dollars doesn’t drastically change your net worth. It feels more like a rounding error.
If you have a $1,000 net worth, $300+ dollars does drastically change your net worth.
As you evaluate your own situation, ask yourself these questions:
- Am I okay with opening another account?
- Will I track when the bond matures and report the interest properly (each year or when you redeem it/matures)?
- Will this move the needle in my financial life?
- Is my time more valuable elsewhere?
I Bonds are reasonable investments if people have cash in their savings account they don’t plan on using in the next year. Compared to other bonds backed by the full faith and credit of the US Government, the interest rate is high. Even 10-year Treasury notes are below 1.5% right now.
The other benefit of I Bonds is that they are a good inflation hedge. Since the interest rate adjusts every six months based on inflation, you will receive more interest if inflation is higher. It also has a floor of 0%, so if the inflation rate is negative on the bond, the composite rate you earn on the bond won’t go below 0%. But, again, it’s only $10,000 that is being hedged against inflation.
If you are worried about inflation though, another alternative if you have cash you don’t need is to invest the money in stocks. Stocks are normally a decent hedge against rising inflation. As inflation rises, companies normally raise their prices, pass along prices increases to consumers, and then the companies’ earnings also go up. As company earnings go up, stock prices usually rise.
Summary – Final Thoughts
I Bonds have high-interest rates in today’s low bond interest rate environment. There is no denying 7.12% is a good rate of return for a bond backed by the full faith and credit of the US Government.
Many corporate bonds, even higher-yielding ones, don’t offer 7.12% interest rates, and they carry much higher risk.
For those with extra cash not needed in the next year, I Bonds are a reasonable place to park the cash. You likely won’t find a savings account or other lower-risk investment that offers a similar rate of return.
Before you purchase I Bonds, consider the time required to buy them, report the interest, and the complexity of having another account. Maybe your time is more valuable, either monetarily or from a peace of mind perspective, than the interest you will earn from the I Bonds.
Most personal finance decisions are not cut and dry. There is a reason the word “personal” is in “personal finance.” What makes sense for me may not make sense for you and vice versa.
I see many people buying these bonds, and although the interest rate is exciting, the actual dollars involved are not for many people. The $10,000 limit makes it so that I Bonds are not going to move the needle on my financial plan, and I try to reduce the number of things that can give me headaches.
Another account, particularly one designed and run by the US Government, could easily become a source of a headache.
Sometimes it’s okay to optimize for reducing headaches if that means it will cost you a few dollars.
The decision is yours.