Savings bonds used to be something that were mostly known for being gifts that grandparents gave their grandkids at birth. Yet when inflationary pressures reared up in recent years to their worst levels since the 1980s, Series I savings bonds -- also known more simply as I bonds -- suddenly got their moment in the spotlight.
The reason is simple: It's not every day that you can get a government-guaranteed return approaching 10%, and the 9.62% offered to those who purchased I bonds between May and October 2022 was a great way to fight back against inflation. Rates on I bonds have fallen since then, but those who buy them today or during the rest of the month of April will get 6.89% for the first six months they own the bond. With inflation continuing to ease, it might seem like a no-brainer to buy I bonds now to get that initial 6.89% rate. However, there's a longer-term consideration to keep in mind that might lead you to prefer waiting on your savings bond purchase.
Understanding I bond rates
I bond interest rates change every six months, and not all I bonds pay the same rate. When you initially purchase an I bond, the Treasury assigns a fixed-rate component that's based on recent conditions in the Treasury Inflation-Protected Securities (TIPS) bond market. That fixed rate remains constant throughout the lifetime of the I bond.
The fixed rate is only half of what goes into the calculation of interest rates at each six-month reset. The Treasury also looks at the Consumer Price Index (CPI), taking the numbers before seasonal adjustment each March and September and comparing them to CPI figures from six months earlier. That determines what's known as the variable rate. To come up with the annualized total rate, you essentially double the six-month inflation rate and then add in the fixed-rate component.
As an example, take the calculation for the I bonds sold between November 2022 and April 2023. The semi-annual rise in the CPI was 3.24%, and the fixed rate on those I bonds was 0.4%. Doubling 3.24%, you get 6.48%, and then adding in the fixed rate boosts that up to 6.89% (including a final small 0.01 percentage-point adjustment).
The trade-off with I bonds
With the release of March inflation numbers earlier this week, we now know that the variable rate for bonds sold between May and October 2023 will fall to 1.69%. That's considerably lower than the current rate and reflects the slowing pace of inflation in the U.S. economy.
However, we won't know until May what the fixed-rate component will be. There's no set rule for determining the fixed rate, but historically, it has tended to track yields on five-year TIPS. Those yields turned positive late last year, prompting the increase from the previous 0% fixed rate to 0.4%. Over the past six months, however, five-year TIPS have yielded between 1% and 2%, spending considerable time above the 1.5% mark. Despite many experts predicting a minimal rise in fixed rates, I believe that the Treasury is more likely to boost the fixed rate to 1% or more based on those figures.
Even if the fixed rate rises to 1%, the resulting combined rate of 4.40% would be well below the current 6.89%. For those who expect to hold I bonds only for the minimum 12-month period, waiting until May won't make much sense.
However, those who expect to own I bonds for the long haul benefit more from a higher fixed rate than they lose by missing out on that initial 6.89% rate. Giving up six months of 6.89% works out to $344.50 if you invest the $10,000 maximum on an I bond. However, if you wait until May and the fixed rate is 1% instead of 0.4%, then you'll earn $60 extra each year that you own the I bond. That makes the breakeven point about six years.
I'm waiting
Because I have a long-term mindset and want the inflation protections that I bonds offer, my plan is to wait until May in hopes of getting the higher fixed rate. If I'm wrong about the size of the fixed-rate increase, then that might turn out to have been a mistake, but that's a bet I'm willing to make.
