What’s The Deal With Series I Bonds?

Inflation, inflation, inflation! You can’t go anywhere these days without hearing the scary “I” word. But what is inflation? Inflation is defined as “a general increase in prices and fall in the purchasing value of money,” but for all practical purposes, it’s the reason your grocery bill has doubled in the past five months.

Why do we care about inflation?

Inflation impacts us in two crucial ways: 1) the cost of all the products and services we purchase become more expensive, drastically impacting our budgets…and not in the good way…and 2) inflation has longer term impacts on how we value our investments.

How does inflation impact my investments?

By definition, inflation decreases the spending power of a dollar tomorrow. When we think about our investments, we are aiming to grow our money over a period of time to not only maintain our buying power, but increase it. In a normal inflationary environment, spending power decreases by about 2% every year. A generous average annual return for the S&P 500 is 10%. That means your real gains are actually 8% because you must back out your lost buying power due to inflation. 

Real growth (8%) = Investment gains (10%) – Inflation (2%)

In a normal environment, I’d take that 8% gain all day. However, we are far from in a normal economic environment. As of August 2022, our annualized inflation rate is 8.3% (which is very high) and the stock market (the most common investment vehicle) is plummeting. So where do we go to avoid stock market losses and try not to lose purchasing power? One answer is I bonds.

Series I bonds

What are Series I bonds?

Series I Savings Bonds, also known as I bonds, are U.S. Treasury-backed savings bonds that return a yield designed to stay ahead of inflation. With a challenging economic and investment environment, you can bet these are gaining in popularity quickly! It’s the closest thing you’ll get to a guarantee to make sure your money isn’t losing purchasing power.

How do Series I bonds work?

Since I bonds are designed to stay ahead of inflation, unlike common bonds and certificates of deposits, I bonds rates are reset every six months. Based on a formula incorporating inflationary data, I bond rates are reset in May and November. Depending on when you purchase the Series I bonds, you will receive that annualized rate of return for the next six months and then the new rate will kick in for the following six months. This resetting process will continue for as long as you hold the bond.

This can get confusing, so lets draw it out:

Assuming you purchased a $1,000 I bond in April 2022, your calculations would look like this.

• Starting I bond value: $1,000
• November 2021 Rate: 7.12%
  • April 2022 – September 2022 
    • $1,000 x (7.12% / 2) = $35.60 gains
    • New principal bond value = $1,035.60
• May 2022 Rate: 9.62%
  • October 2022 – March 2023
    • $1,035.60 x (9.62% / 2) = $49.81 gains
    • New principal bond value = $1,085.41

As you’ll see in the example above, we earned an annual rate of return of 8.54%. This is not only keeping up with inflation and likely outperforming a struggling stock market, but also virtually risk free. So, is it too good to be true? I’m glad to say it is that good, but there are some things worth noting before you jump in.

Benefits and limitations of Series I bonds

Series I bond benefits

• Safe Investment
  • I bonds are a safe investment because they are backed by the whole weight of the U.S. Government. So unless the government decides to go bankrupt while you hold the bond, your return is guaranteed.
• Liquidity
  • I bonds are more liquid than a long-term bond, because once you’ve held the I bond for one year, you’re free to cash it out, albeit with some limitations discussed below.
• Keeping ahead of inflation
  • The whole purpose of I bonds is to make sure your money maintains purchasing power greater than the downward pressures of inflation. While over the long term, I bonds are not a substitute for riskier investments, they are a good supplement to using normal savings or high-yield savings accounts.
• Semi-annual compounding
  • Every six months, the interest gained will be added to your principal, allowing for greater gains once transitioning to the next interest rate.

Series I bond limitations

• Old school government website
  • The first downside to I bonds is the administrative process of buying them. While it’s pretty easy to buy them, the government website looks like it hasn’t been updated since the 1990s. I believe they may be working on modernizing it, but at the end of the day it’s a clunky government website.
• 1-year locked holding term
  • Once purchasing an I bond, you won’t be able to access that money for at minimum one year. While this is shorter than most CDs or long-term bonds, if you know you will need to use this money in the next 12 months, I bonds may not be a good fit.
• 5-year maturity penalty
  • I bonds do not reach full maturity until 5 years. What this means is that if you pull out your money prior to 5 years from your purchase month, you will be assessed a 3-month interest penalty. So if you held your I bond for 18 months and then cashed it out, you would only receive 15 months of interest gains.
• $10K annual limit
  • I bonds have an annual limit of $10K per social security number. This can be limiting if you’re trying to invest large amounts of money. The nice thing is, for families, you can open I bond accounts for your partner and kids. So a family of four could invest up to $40K per year.

How to buy Series I bonds

While the Treasury Direct website is clunky, creating an account and purchasing I bonds is pretty straightforward.

Here are the steps to buy I bonds:

1. Go to the Treasury Direct website.
   1. You can also find some additional great details about I bonds at this link.
2. Click “Log In” at the top right of the webpage.
3. Once on the “Log In” page, click the “Create an New Account” button on the right side of the page.
4. Click “Apply Now” on the bottom of the page.
5. Determine which type of account you’d like to open. For most people, you will just open an individual account (the top option).
6. Finish filling out the form and create your login information. 
7. Once logged in, click “BuyDirect” on the top and then select the “Series I Savings Bond” option.
8. Then connect a bank account, select the amount you’d like to purchase, and click “submit” on the bottom.
9. You are now the proud owner of a Series I Savings Bond!

Diversify your financial exposure

I bonds are a fantastic savings option in these uncertain, inflationary times. But, I bonds are just one tool available to you as you build out a diversified financial portfolio. Better understanding tax-advantaged 401Ks and individual retirement accounts (IRAs), regular brokerage accounts, and even real estate will help you determine the right exposure to financial risk for your individual circumstances.

Check out additional topics to make personal finance SLIGHTLY EDUCATIONAL on our Personal Finance page.