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Rekenthaler Report

An Update on I Bond Yield

Although their future I Bond yield has slipped, they remain an excellent bargain.

Illustrative photograph of John Rekenthaler, Vice President of Research for Morningstar.
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The Bad News

September’s inflation report was unkind to Series I Savings Bonds, commonly known as I Bonds. The announcement that core inflation rose 0.6% in August sent stocks and bonds reeling. Yet inflation’s resurgence failed to benefit I Bonds, which typically profit from higher prices. The statistic that determines their yield (seasonally unadjusted CPI-U) includes the effect of energy prices, which dropped 10% for the month. That movement offset price hikes elsewhere.

Nevertheless, I Bonds were the markets’ relative star. Not only did stock and bond prices plummet, but commodities continued their retreat. Over the past three months, iShares S&P GSCI Commodity-Indexed Trust, an exchange-traded fund that tracks various commodities, has shed 15% of its net asset value. Pity those investors who decided in June to hedge their portfolios against inflation by buying commodities! Compounding the misery, gold once again failed to answer inflation’s call, and bitcoin … oh, why I do even bother? Cryptocurrency prices went splat, of course.

Compared with the investment alternatives, going nowhere seems acceptable. Also, as I previously have discussed, yields on I Bonds lag contemporary events. Their distributions reflect not what is happening today, but instead what occurred several months ago. Eventually, September’s inflation report will reduce I Bonds’ payout, but that adjustment will not affect new I Bond owners until next spring.

How I-Bond Yields Are Assigned

Whenever an I Bond is purchased, the Treasury guarantees that security’s yield for the next six months. The current guaranteed rate is an annualized 9.62%—very pleasant work if you can get it. That figure represents the change in the seasonally unadjusted CPI-U from October 2021 through March 2022. Those who buy an I Bond this month will receive that yield until February 2023, after which they will be assigned a different payout.

What that next yield will be has yet to be established. However, we can estimate it quite closely. For the five months from April through August, the CPI-U index increased by 3.015%. If the index were to remain unchanged in September, as essentially was the case in July and August, then new I Bond investors would receive an annualized payout of 6.03% for the second six months of their ownership. Their one-year return would therefore be 7.82%, or (9.62% + 6.03%)/2.

Advantages of I Bonds

Since 11 of those 12 months have already been booked, and energy prices are down in September, implying a third-straight month when their declines will flatten the I Bond inflation adjustment, the final amount will almost certainly be very close to that preliminary figure. For those who buy I Bonds now—the math can differ for current owners—the first year’s payout will be 7.8%, give or take.

Which continues to make I Bonds compelling for the near term. Although they carry 30-year maturity dates, which normally would disqualify them from being considered as short-term investments, I Bonds afford their owners unusual flexibility. Whereas conventional bonds cannot be redeemed early, instead being required to be sold in the open marketplace, the Treasury will always exchange an I Bond for its par value if the investor has owned that security for 12 months. Effectively, I Bonds possess whatever maturity date the investor desires.

True, investors who sell I Bonds after possessing them for less than five years must forfeit the most recent three months’ worth of interest. Consequently, I Bonds will require 15 months to deliver that 7.8% expected return rather than 12 months—the first year spent collecting the I Bond yield, followed by the final three months awaiting the sell date. That is still terrific. The current payout on a 15-month bank certificate of deposit is about 3.75%, and unlike an I Bond, a bank CD does not give its owner the right to continue to hold the security should rates move in its favor.

The final advantage of I Bonds is that they are sheltered from federal taxes, until they are redeemed. Before then, they are federal-tax-free, as with investments that are contained within a 401(k) plan or an IRA account. The analogy is imperfect because I Bonds accrue interest rather than paying it along the way, but close enough.

Disadvantages of I Bonds

However, I Bonds also have their quirks.

1) Investment limits

Because I Bonds were designed for the investment masses, as opposed to institutions, they cannot be purchased in large quantities. The individual maximum $10,000 per year. In practice, though, families may be able to buy several times that amount, because accounts may be established for each child (and for a spouse), as well as for businesses and living trusts.

2) Operational inconvenience

I Bonds are unusually cumbersome. Not only must they be held with the U.S. Treasury, and thus separated from an investor’s other assets, but the individual accounts cannot be mingled, even within a family. Finally, while the Treasury grants investors permission to buy an additional $5,000 worth of I Bonds per year with their federal tax refunds, that right comes with the stipulation that those bonds be in paper form, rather than electronically registered. The land that time forgot!

3) Inheritance headaches

The administrative troubles extend after one’s death. Writes Bill Bernstein, “God save your heirs when they must access I Bond assets—if they can even figure out that you have them, which is much less likely than with a conventional brokerage account, which will leave a more robust paper trail.” With I Bonds, points out another reader, “secondary beneficiaries are not allowed. That means if my spouse and I plunge into the Atlantic next month, our estate will go into probate.”

The moral of the story: I Bonds are presently a good thing. But if you own them, do stay alive.

Note: Several readers have notified me that I have exaggerated the difficulties associated with having beneficiaries for I Bonds. There will be somewhat more work than simply adding another holding to an existing brokerage account, but the task can be accomplished. So, perhaps that caveat can be struck from the list or at least downplayed. It remains valid advice to stay alive, though!

John Rekenthaler (john.rekenthaler@morningstar.com) has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.