In this clip from "Financial Planning Q&A 60" on Motley Fool Live, recorded on Jan. 26, Motley Fool contributor Dan Caplinger analyzes whether I bonds make for a good deal or not, given inflation and the uncertainty of future interest rates.
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Dan Caplinger: "The I Bonds have a great starting interest rate. What happens to that rate after the first period is over? Does that make it less of a buy?" Mary, good for you for being skeptical because, I'll admit, I wrote the article and the article gets a headline, "Hey, you can get 7.12% on your I Bond investment" and that is true for six months. Then, after six months, that rate resets. The way that it works, Mary, is that each six months you look at a particular measure at the Consumer Price Index. You calculate how much that has changed in that six-month period. Then, you do a complicated calculation formula that is close enough to doubling the change, that I'm just going to say, you basically doubled the change. In order to get the 7.12%, it's basically because inflation went up during that six-month measuring period about 3.56% and, when you double that, you get 7.12%. Now, if inflation turns out to be 3.56% again during the next measuring period, then the rate for the I Bond for the following six months will stay at 7.12%. If inflation rates go down from that, then the rate will fall. If inflation ends up being higher than that, then the rate will rise. You do that every six months for as long as you hold onto the bond, and you can hold onto the bond for 20-30 years. That interest rate is going to change each six months depending on what that is.
Now, does that make it a bad deal or a good deal? Well, it depends. In one sense, you don't know if it's a great deal because you don't know what the future interest rate is going to look like. What I can say though, is that it offers you a better deal than you would be able to get if you bought a different kind of inflation-protected bond. These are the Treasury Inflation-Protected Securities whereas the I Bond, essentially, pays you the full inflation rate. If you go out and buy one of these TIPS securities on the open market, you have to accept a negative real interest rate on top of that inflation payout in order to get the same protection. Based on that, I think it's a good buy but don't be fooled. You're not likely to get 7.12% for much more than that six-month initial period. After that, it's going to reset and, hopefully, inflation will get under control and we won't have to worry about that much loss of pricing power. Even if it does mean lower rates on this I Bond, odds are still pretty good that they're going to be better than the 0.4 or 0.5 that I'm seeing with these so-called high-yield savings accounts yield.