The stock market has plunged sharply in the past few weeks, with the Dow Jones Industrials (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) on the verge of falling into their first official bear market since the financial crisis in 2008. Many investors are suffering, seeing much of the gains they've enjoyed over the past decade go up in smoke. They're also looking for ways to protect some of their money from further stock market declines, especially given the uncertainty surrounding events like the Covid-19 outbreak and the price war among oil-producing companies worldwide.
There's one choice that many investors don't even see as a real investment, instead being a favorite gift for grandparents to give to young children to help them with their financial futures. Series I savings bonds aren't going to make you rich, but they will preserve your wealth -- and they'll do so in a way that professionals on Wall Street can't match right now.
What are Series I savings bonds?
The U.S. Treasury issues savings bonds, backing them with the full faith and credit of the federal government. That makes them comparable to Treasury bonds as having no real risk of default.
Savings bonds come in different series, and Series I savings bonds -- also known as I bonds -- have particularly interesting features. I bonds earn returns based on two things: a fixed interest rate plus changes in the Consumer Price Index. Currently, I bonds have a fixed rate of 0.2%. However, with the CPI having risen by slightly more than 1% over the most recent six-month measuring period, I bonds issued through April will carry an initial total interest rate of 2.22%.
That's not a huge return, but take a look at how it compares to what Wall Street pros can buy:
- Short-term Treasuries with maturities of five years or less are all yielding less than 0.5%.
- Even yields on 10-year and 30-year Treasuries fell to rock-bottom levels earlier this week, with 10-year Treasuries falling to 0.3% and 30-years briefly hitting 0.7%.
- All of the inflation-indexed securities that institutional investors can buy currently feature negative real interest rates. For instance, 10-year Treasury Inflation Protected Securities currently have an effective yield of -0.4%. That makes the positive 0.2% yield on I bonds look generous by comparison.
A special deal for small investors
The reason Wall Street's finest will be jealous of you is that I bonds aren't available to institutional investors. There's a $10,000 per person annual limit on purchasing I bonds as well, making them best suited for small investors with modest savings.
It's important to understand that I bonds are designed for long-term investors. You can't cash them in until a year has passed, and if you cash them in before five years, then you'll have to pay a penalty of three months of interest. That makes I bonds more like long-maturity bonds or five-year CDs than a savings account.
I bonds also carry some tax advantages over Treasury bonds and most other fixed-income investments. Interest is free of state income tax, and you don't have to pay tax on accrued income until you cash in the savings bonds. For certain purposes, such as paying educational expenses, interest income on I bonds can be tax-free federally as well for some taxpayers.
Perhaps most importantly, I bonds will never drop in value. Even if the CPI went negative and there was extensive deflation, I bonds will never see their interest rate fall below 0%. That might not sound like a big deal, but in an environment in which more and more institutional bond investors are accepting negative interest rates in exchange for safety, I bonds look attractive.
Take a look at I bonds
I bonds are never going to be a replacement for stocks, because the growth potential of stocks is so much greater than what I bonds will ever pay. For those looking at adding bond exposure to their portfolios in order to improve their asset allocations , however, I bonds have big advantages over most other fixed-income alternatives.