Given the high rate of inflation hitting consumers right now, it's no surprise to see investors trying to do what they can to protect themselves. Yet it's been hard to find a good defense in the financial markets from higher consumer prices, as both stocks and bonds have seen their prices fall precipitously in 2022.
Against that backdrop, the 9.62% rate that Series I Savings Bonds offered between May and October 2022 looked almost too good to be true. Indeed, the rate that will apply to I bonds sold between November 2022 and April 2023 is going down. But there's a key advantage that these new bonds will have that could make them even more valuable in the long run.
What are I bonds?
Millions of Americans have recently discovered I bonds because of that attractive 9.62% rate. It's essentially risk-free as the U.S. Treasury backs up the bonds with the full faith and credit of the federal government.
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That generated a lot of buying interest from the general public. Just on a single day, Oct. 28, the Treasury sold $979 million in I bonds, setting a new record. That was the deadline to lock in the 9.62% for the first six months of the bond.
Those numbers are particularly impressive given that savings bonds are designed to be accessible to small investors. You can buy bonds with as little as $25, and there's a $10,000 limit per taxpayer on I bond purchases annually.
A change in two key rates
I bonds are unusual in that their value gets adjusted to account for inflation. Twice a year, the Treasury takes the six-month change in the Consumer Price Index and then uses a formula to determine what the I bond rate will for the next six months. It's because inflationary pressures subsided somewhat that the new I bond rate is dropping to 6.89%.
However, there's good news hidden in that number. When you look only at the impact of inflation, many expected the rate to be just 6.48%. However, the Treasury also included a positive fixed rate of 0.40%, and that will apply throughout the 30-year life of the I bond.
What that means is that bonds sold in November and later will have a long-term advantage over those sold between May and October. After six months, the earlier-sold I bonds will get their interest rate adjusted to reflect more recent inflationary trends. When that happens, the rate for the following six months will be 6.48% rather than 6.89%, because the fixed rate for those earlier I bonds was 0% rather than 0.4%.
Catching up over the long run
The downside, of course, is that newly sold I bonds won't get six months' worth of interest at 9.62%. However, if you anticipate holding your I bonds for a long time, then the steady advantage of roughly 0.4 percentage points year after year will eventually help the value of your I bond catch up.
Admittedly, some investors aren't interested in the long run. You can cash in your I bonds as early as 12 months after buying them. If you hold them for five years or longer, then you can avoid the penalty of three months' worth of interest at redemption.
However, I bonds also come with tax advantages, as you don't have to claim the accrued interest on I bonds until you redeem them or at maturity. With a 30-year term, that gives you a lot of flexibility. So if you missed out on getting an I bond in October, it's not too late -- and you might actually end up with an even better deal in the long run.
