COLUMN: Understand the pro’s, con’s of I Bonds

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Michael Lewis wrote a fantastic book about the 2008 housing market collapse, titled “The Big Short.” This was later made into a movie starring Christian Bale, Ryan Gosling, Steve Carrell and others.

It was quite entertaining and pretty darn accurate.

In the film, Ryan Gosling’s character describes bonds. “We all know about bonds. You give ‘em to your snot nose kid when he turns 15 and maybe when he’s 30 he makes a hundred bucks. Boring.”

Which leads us to present day.

There is a lot of buzz around “I Bonds” currently and it’s understandable – in a volatile market, people search for alternatives. And when something touts nearly a 10% return, it gets your attention. Hence, it’s worth it to have a little primer on I Bonds, courtesy of our team’s bond guru, Mad Max Berkovich. Max knows bonds like Joey Chestnut knows hot dogs.

What are they? They are a bond issued by the U.S. Treasury designed to protect your investment from losing value due to inflation. The bond will pay a fixed interest payment set by the Treasury until maturity.

The bond also pays an inflation-adjusted rate that is determined by the rise and fall of inflation per the Consumer Price Index.

Combined, these rates make up a composite rate and this rate is paid out for 6 months and after 6 months, it is adjusted again, done every May and November.

The benefit, and what’s gathering attention now, is that with inflation running very high, the composite rate is also high currently, a 9.62% annual rate with no risk to principal. Tax benefits are that you can defer the taxes to maturity or redemption or avoid them altogether if they used for college tuition; they are also exempt from state and local taxes.

So, what’s the rub? For one, the fixed interest payment is currently zero and has been since 2020, and less than 1% since 2007. This fixed rate is for the life of the bond. There are limits to purchasing them — $10,000 annually and another $5,000 if using a tax refund, per person. The bond must be held for a year and if redeemed within 5 years, a penalty will be incurred of 3 months of interest.

The purchase of these bonds is a bit of an administrative hassle as well. They can’t be done through your broker or financial advisor; they must be bought directly through the Treasury Direct website.

And while there is no predicting where inflation is going, we’ve already experienced a tremendous spike with it sitting at 9.62%.

The Federal Reserve is actively fighting to lower the inflation rate and most expect to see the year over year inflation rate to come down from present levels. If the Fed is successful and inflation falls, the inflation adjusted rate falls as well. Lastly, keep in mind, that the yield is annualized, meaning that until the next reset, the actual yield is 4.81%.

These bonds aren’t a new discovery. They’ve been here. They can be a great college savings vehicle or an excellent addition to your cash or money market liquidity buckets; and perhaps a better option than bank CDs. But as an alternative to a diversified portfolio that you are basing your retirement on – between the limits on what you can buy and the zero fixed interest rate, and where inflation rates historically settle – the bonds might not be what the media is having you believe. Shocking, I know.

Original content provided by Gregory Mattacola, Esq., CFP, Lead Advisor at Strategic Financial Services. Content is provided for educational purposes only and should not be used as the basis upon which to make investment or financial decisions. Investments involve risk and, unless otherwise stated, are not guaranteed.  Past performance is not indicative of future performance.

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