Exploring iBonds paying 9.62% Interest

Yep, there are bonds backed by the government guaranteeing 9.62% interest right now.

It’s almost free.

This is not financial advice but meant to be a look into why iBonds might be a super attractive alternative to traditional assets right now.

Free is great, but “free” usually is an elaborate (and occasionally, blatant) attempt to part us from our hard-earned money. For the money-savvy, it’s natural to be suspicious of anything that’s “free” and rightly so.

There have been a few notable examples of truly free money in recent memory with the pandemic stimulus checks clearly taking the prize. Across 3 stimulus checks, eligible Americans had $3,200 airdropped straight into their bank accounts, no strings attached.

A more everyday example most are familiar with is the interest we earn in our bank accounts. However, they tend to be quite underwhelming with regular banks offering 0–1%.

Of course, we can always make the argument that stimulus checks may have contributed to current inflation and holding excess money at banks is giving up the opportunity cost of doing something with that money, making neither truly free, but that’s a discussion for another time.

This brings us to US Savings Bonds or specifically Series I Saving Bonds backed by the United States government, which I’ll be referring to as iBonds.

Recall, that the stock market on average returns 10% per year, and one of the reasons investing for the long term is so powerful. The downside is higher volatility compared to other assets, which this year is doing a fantastic job of demonstrating.

So to have 9.62% guaranteed by iBonds in an environment where asset prices are selling off in tandem is quite mouthwatering.

So what’s the catch?

Well, there are definitely a few caveats.

The first is that you can only buy $10,000 in iBonds each year, so if you have a significant amount of money to put to work somewhere, you’ll only be able to park a portion of it here.

Technically, you can buy $15,000 a year, but that requires utilizing tax returns and is probably too niche for this article.

The second is that you can’t just buy and sell these as you would with stocks, but rather are subject to a 12-month holding period, so make sure that any money that goes into these will not be needed for at least a year.

Alongside this, there’s a soft penalty for cashing out before 5 years, where the last 3 months of interest are given up, which may not matter if the rate at that time is exceptionally low.

Most importantly, the rate itself is only locked in for 6 months starting from the date of purchase at which point the rate updates based on inflation.

Current iBond rates are only locked in for bonds purchased up to October 2022.

As just mentioned, these bonds have their interest determined by inflation and as we know from the ever incessant news or perhaps by just glancing at gas prices, inflation has been having a field day over the last year.

Hence, the current super attractive iBond interest rate.

If we look at past rates, we see that they were quite modest and only began picking up in the last few periods.

Breaking down exactly how the rate is calculated, we see that these bonds have two components to them, a fixed interest rate and a variable rate that’s pegged to inflation.

Now the fixed interest rate portion has been paying ~0% since 2020.

Boring and not very valuable, but…

Due to the bonkers inflation numbers we just mentioned, the variable rate has been increasing to keep pace.

So how do we get to 9.62%?

The variable rate actually takes 2x the inflation rate for 6 months, resulting in the following calculation to arrive at our combined rate:

fixed (0%) + variable (4.81% x 2 = 9.62%) = combined (9.62%)

Let’s dive into the variable component a little more.

If we actually somehow enter a period of deflation, where the price of goods drops, the variable rate can go negative.

But taking the rates since 1998, we see rates have only gone negative twice. Though past performance is never indicative of the future, it does serve as a good starting benchmark.

The bright side? iBonds cannot have a combined rate that’s negative, so cannot actually go below 0%.

In fact, we can actually expect the rate for the next period to likely be even higher than the current period due to the persistently high inflation numbers that have been coming out.

I’ll close with a few more details about these bonds that make them more attractive:

  • Tax on the interest can be deferred until the bond is redeemed
  • Interest is exempt from state and local taxes
  • The bonds last for 30 years

Altogether, this means that iBonds can be an incredibly tax-efficient savings vehicle. They tend to pay at least the interest you would get from parking your money at a bank without being subject to taxes on the (measly) interest you earn every year.

So recapping, iBonds currently pay 9.62% until October 2022 at which point they’ll update to a new value pegged to inflation.

Check them out for yourself at TreasuryDirect and see if they’re a good fit for you. (Heads up, it’s kind of a pain to work through their interface.)

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