I Bonds Are All the Rage Right Now. Are They a Good Pick for Your Portfolio?

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KEY POINTS

  • I bonds are U.S. government debt obligations that pay a rate related to inflation.
  • High rates of inflation have boosted I bond rates to nearly 10%.
  • With uncertain yields and lengthy holding requirements, I bonds are far from perfect savings vehicles.


Meet the bonds making debt investing sexy!

Seemingly overnight, Series I Savings Bonds (known as I bonds for short) have become the talk of the town. What are I bonds, and why are they enjoying a renaissance? Read on to find out.

What is an I bond?

At its core, an I bond is just another version of debt issued by the U.S. Treasury. However, their headline-snatching power lies in one thing: variable interest rates. Unlike a traditional bond, where rates are fixed until maturity, an I bond's interest rate is calculated by adding a fixed rate to the rate of inflation. This means that when inflation is on the rise, interest rates offered on I bonds are, too.

There are a few other things you should know about I bonds. First, they mature in 30 years, but can be cashed out penalty free after a holding period of five years. I bonds cannot be cashed out prior to 12 months after purchase. I bonds are issued in amounts to the cent, over $25. This means that you can buy an I bond worth $25.01 if you want to. Additionally, any U.S. citizen or resident who has a Social Security number can purchase I bonds, and they can be purchased for or gifted to children. However, eligible purchasers can only buy a limited amount of I bonds in a year.

As mentioned above, the most distinguishing feature of an I bond is its interest rate, which rises with inflation. And for those living under a rock: inflation is high right now. Currently, inflation rates are over 8%, well above the average of 2%. Against that backdrop, interest rates on I bonds have reached tremendous heights. Currently, I bonds yield 9.62%.

This is a big deal because of a mismatch between risk and reward. Typically, high reward, like a high interest rate, cannot be achieved without taking on proportional risk. So, when the U.S. Treasury, one of the "safest" debtors around, offers returns nearing that of the stock market, investors tend to take notice.

Looking for current rates? Check out our Best CD Rates.

Before you buy…

While interest rates may be high now, they aren't guaranteed to stay that way. I bond rates are recalculated every 6 months, so a 9.62% interest rate today doesn't mean a 9.62% rate in the future. In an economy where interest rates typically hover around 2%, a return to normalcy will also mean a return to lower rates on I bonds.

And if you're not careful, you will be stuck with those rates for some time. I bonds must be held for one year before you can cash out, should the rate drop dramatically. And cashing out before 5 years have passed carries a heavy cost -- a haircut of three months of interest off the value of the bond. Buying an I bond means that you are locked in for some years, or will be forced to pay the price.

U.S. citizens and residents can only purchase $10,000 worth of I bonds in any given year, meaning that relatively low risk, high reward I bonds probably won't make or break your investment account. While I bonds are currently a very attractive investment, buyers should consider their ability to weather future rate changes and to hold on for the long term before buying.

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