One of the current best deals in the bond market – Treasury Series 1 savings bonds – is likely to become less attractive in November when a new price is set for popular investments.
Individual investors may want to snap up inflation-linked bonds before the end of October to get the current interest rate of 9.6% for the first six months. The new rate applied to bonds purchased in November is likely to be closer to 6%, Baron Estimates, based on the formula used by the US Treasury to calculate the semiannual rate.
The main disadvantage of I bonds is that individuals can only purchase $10,000 per year, although an additional $5,000 can be purchased using federal tax refund returns. Americans who own certain businesses can purchase $10,000 annually in I Bonds through these entities. I bonds must be purchased directly from Treasury through its TreasuryDirect program.
The rate on I bonds, based on the US Consumer Price Index, hit a record 9.6% for bonds purchased starting in May and continuing through the end of October due to higher inflation in late 2021 and early 2022. But price increases eased in recent months as the CPI surged Headline 0.1% in August. Treasury has been selling I bonds since 1998.
“You should buy now,” says John Shearer, founder of Trinity Financial Planning in Middleton, Wisconsin, and says the current rate compares very favorably with bank certificates of deposit.
Investors have responded to Series 1 bond yields since the 9.6% rate was set in May. Bond issuance totaled $12.7 billion from May through August, including record monthly sales of $5 billion in May, according to Treasury data.
In the previous six-month period from November 2021 to April 2022, 1 Treasury bond issuance totaled $12.9 billion when the rate was 7.1%. The average monthly issuance of $2.7 billion so far in 2022 compares to just $30 million in monthly sales in early 2021 when the rate was just 1.7%.
Bond prices reflect both the CPI-based inflation component and what the Treasury calls a fixed rate, which is now zero. The inflation rate is set twice a year in early May and November and applies to bonds purchased in the following six months. The flat rate will also be reset in November and will likely be at or near zero.
The May interest rate of 9.6% was based on the CPI from September 2021 through March 2022.
The Treasury uses the non-seasonally adjusted CPI, which differs slightly from the more prominent seasonally adjusted CPI that grabs the headlines every month. The non-seasonally adjusted CPI increased by 4.8% from September 2021 through March 2022. This amount is multiplied by two to arrive at a rate of 9.6%, which applies to bonds purchased from May through October of this year.
The new rate, which will be announced in early November, is based on the CPI from March through September. Baron He calculates that consumer prices rose 3% from March to August, the most recent report. Assuming little change in September prices, the new rate should be around 6%.
Investors who buy I bonds before November 1 will receive a 9.6% rate for the first six months they own the bond and then the new rate for the next six months.
“I Bonds are definitely a great safe investment to supplement your emergency funds,” says Ken Tommen, founder and editor-in-chief of the Bank Deals Blog.
Bonds must be held for at least one year and bonds redeemed before five years are subject to a quarter interest penalty. Tumin sees the interest penalty as modest for bank certificates of deposit, which usually carry early withdrawal penalties.
Two nice features of I bonds are that investors can defer taxes on interest payments until maturity – the bonds can be held for 30 years. And I do the interest on bonds, like those on other Treasuries, exempt from state and local taxes, in contrast to bank certificates of deposit and corporate bonds.
The risk of bonds is that inflation decreases and leads to lower interest rates in the coming years. This is a distinct possibility with markets discounting inflation by about 2.5% over the next five and ten years. But if inflation remains stubbornly high, I Bonds will look especially good.
Investors who wish to acquire inflation-linked bonds can also purchase Treasury Inflation Protected Notes (TIPS), which are regularly auctioned by the Treasury and available through TreasuryDirect, banks, and brokerages. They are issued with maturities of five, 10 and 30 years. TIPS is not subject to restrictions on purchases made by individuals.
The advantage of TIPS over I Bonds is that they now offer a real interest rate, or interest rate inflation rate, of around 1%, which means that shareholders get the inflation rate plus 1%. However, prices for TIPs can fluctuate and are down this year as real returns have gone from negative 1.5% to positive 1%. The real yield on I bonds is now zero.
There is a less risky way to own TIPS through ETFs like
iShares 0-5 Years TIPS Bond ETF
(Stock ticker: STIP) which now carries a total return of approximately 10% based on a calculation using Securities and Exchange Commission guidelines. Its real return is around 1.5% and is supplemented by an inflation adjustment.
Write to Andrew Bary at firstname.lastname@example.org