I bonds are all the rage right now. Are they a good choice for your wallet?
Check out the bonds that make debt investing sexy!
- I bonds are US government debt securities that pay a rate linked to inflation.
- High inflation rates have driven I bond yields to close to 10%.
- With uncertain returns and extended holding requirements, I bonds are far from perfect savings vehicles.
Seemingly overnight, Series I Savings Bonds (known as I Bonds for short) became the talk of the town. What are I bonds and why are they experiencing a renaissance? Keep reading to find out.
What is an I bond?
At its core, an I bond is just another version of debt issued by the US Treasury. However, their power to grab headlines 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 inflation rate. This means that when inflation is up, so are the interest rates offered on I bonds.
There are a few other things you should know about I-bonds. First, they mature in 30 years, but can be redeemed without penalty after a five-year holding period. I Bonds cannot be redeemed until 12 months after purchase. I bonds are issued in penny amounts, plus $25. This means that you can buy an I Bond worth $25.01 if you wish. Additionally, any U.S. citizen or resident who has a Social Security number can purchase I Bonds, and they can be purchased or gifted to children. However, eligible buyers can only buy a limited number of I bonds per year.
Why are I bonds so popular?
As mentioned above, the most distinctive feature of an I bond is its interest rate, which increases with inflation. And for those who live under a rock: inflation is high right now. Currently, inflation rates are above 8%, well above the 2% average. In this context, interest rates on I bonds have reached considerable heights. Currently, I bonds yield 9.62%.
This is a big problem due to a mismatch between risk and reward. As a general rule, a high reward, such as a high interest rate, cannot be obtained without taking a commensurate risk. So when the US Treasury, one of the “safest” debtors, offers returns close to those of the stock market, investors tend to take notice.
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Although interest rates may currently be high, there is no guarantee that they will remain so. Bond rates are recalculated every 6 months, so an interest rate of 9.62% today does not mean a rate of 9.62% in the future. In an economy where interest rates typically hover around 2%, a return to normal will also mean a return to lower rates on I bonds.
And if you’re not careful, you’ll be stuck with those rates for a while. I bonds must be held for one year before they can be cashed in, if the rate drops dramatically. And cashing in before 5 years has passed has a high cost – a three-month interest discount to the value of the bond. Buying an I bond means you’re locked in for a few years or you’ll be forced to pay the price.
U.S. citizens and residents can only buy $10,000 of I bonds in any given year, which means relatively low-risk, high-yield I bonds probably won’t make or break your account. ‘investment. Although I bonds are currently a very attractive investment, buyers should consider their ability to weather future rate changes and hold to them for the long term before buying.
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