The stock market has been extremely turbulent in 2020, plunging in the coronavirus-inspired bear market but then soaring back upward to send some stock indexes to new record highs. The amount of volatility has thrown even seasoned investors for a loop.
Many are worried about their ability to survive what's likely to be a significant recession in the months to come. Moreover, as COVID-19 case counts rise, the prospects for another damaging round of business closures are becoming even more alarming.
Now's not the time to panic, especially if you've stayed the course and kept your portfolio relatively unchanged throughout the year so far. Now that stock market benchmarks have bounced back, it's a good time to look at whether you should rebalance your investments to bring risk levels back in line with your comfort level. If that results in having some spare money floating around, there's a smart move you can do that will help you protect against a key risk that every investor faces right now.
The danger of inflation
Inflation hasn't been a big worry for investors in decades. You have to go back all the way to the oil price shocks of the late 1970s and early 1980s to find a time when U.S. market participants had to worry seriously about inflationary pressures.
Yet the extreme measures to which central banks and the federal government have gone in order to promote economic growth have some market watchers worried about the future. With trillions of dollars in stimulus packages so far -- and more likely on the way -- it's natural to worry that all that spending could eventually lead to a loss of confidence in the government's handling of its fiscal responsibilities.
Those concerns are a big part of why prices of traditional inflation hedges like gold and silver have risen dramatically. In addition, inflation-protected bond securities from the U.S. Treasury -- also known as TIPS -- have become so popular that their real interest rates have gone negative.
However, there's an alternative that individual Americans have exclusive rights to use. Most people don't even think of U.S. Savings Bonds as a real investment, but one particular type of savings bond is doing a better job of protecting against inflation than just about any other choice.
Fight inflation with I Bonds
I bonds -- shorthand for Series I U.S. Savings Bonds -- are designed to protect savers from inflation. Rather than carrying a set interest rate that you'll receive throughout the period that you own the savings bond, I bonds see their rates fluctuate every six months.
Currently, I bonds offer a 0% real rate, meaning that they don't pay any fixed interest. The only income they generate comes from the rise in their value from their link to the Consumer Price Index (CPI). I bonds that you purchase currently carry a rate of 1.06%, because the measure of inflation that I bonds use was up 0.53% during the six-month period from September 2019 to March 2020. That rate will apply for the first six months, and then the government will calculate a new rate based on inflationary changes between March and September of this year.
Admittedly, 1.06% isn't a great return. But bear in mind that the rate will fluctuate up and down. It can't go below 0%, but it can go as high as it needs to in order to keep pace with inflation. For instance, in the previous six months, I bonds paid 2.22% in interest.
Moreover, the 0% real rate is a lot better than what institutional investors are doing. Right now, Treasury investors are accepting 0.15% in interest on two-year Treasury notes without inflation protection. TIPS with maturities of five years are paying 1.15 percentage points below the rate of inflation. Even with longer maturities, the news isn't much better, with 10-year TIPS yielding -0.91% and 30-year TIPS yielding -0.35%.
Stockpile a bit of cash with I bonds
I bonds weren't designed as a short-term parking spot for unlimited cash. Investors face a $10,000 annual limit on I bonds per person. You can't cash in an I bond for 12 months, and if you do so before five years have passed, you'll forfeit three months' worth of interest.
Nevertheless, by giving investors a hedge against inflation, I bonds have unique characteristics you won't find in most investments. With all the uncertainty about the stock market right now, protection from loss looks pretty attractive. Take a closer look at I bonds if you have cash to spare, and you might like what they offer you.