In the Money Insight: Everything You Need to Know About I-Bonds
I was recently joined on In The Money Insight by Matthew Navickas, AAMS®, an investment analyst here at Falcon Wealth Advisors. We discussed an investment several clients have asked me about in recent months: I-Bonds. A summary of our conversation is below.
Cory: Thanks for joining me, Matthew. What’s an I-Bond and why are so many people interested in them?
Matthew: I-Bonds are bonds offered by the US government that can help investors hedge against inflation. As inflation rises, so do the interest rates on I-Bonds—and with inflation at levels not seen in decades, I-Bonds are currently yielding more than 9%.
Cory: Yes, and this means I-Bonds are more appealing to investors than at other points in recent years. People are attracted to I-Bonds because they are indeed currently returning nearly 10% while not exposing investors to very much risk, given that I-Bonds are backed by the US government. I recently read there were between $11-12 billion worth of I-Bonds purchased in the first several months of 2022, compared to $1 billion during the same time period last year.
It’s worth noting that investors have to purchase I-Bonds directly from the US Treasury. Fiduciary wealth advisors like our team are unable to purchase them for clients (though we can help guide you through the process).
What are some of the limitations around I-Bonds?
Matthew: First off, a person can only buy $10,000 worth of I-Bonds each year—though a couple could buy a total of $20,000 worth of I-Bonds.
However, there are some loopholes available. You have the option of using money from a tax refund to purchase paper I-Bonds, which is a way to invest more than $10,000 in I-Bonds. And you can buy an I-Bond in the name of your business or child.
Another limitation is that interest rates are adjusted each May and November. It’s possible that later this year, if inflation goes down, interest rates on I-Bonds will not be as high as they are currently—meaning investors may not continue to be able to earn close to 10%.
This is relevant because investors have to hold their I-Bonds for at least five years to reap its full benefits. If you sell at any point between one and five years, you lose your last three months of interest earned. And investors are required to hold I-Bonds for at least one year.
Cory: Thanks, Matthew. While we can’t invest large sums of money in I-Bonds, they are still a useful way for everyday investors to combat inflation.
Can you talk about how the interest on I-bonds is paid?
Matthew: Interest is paid every six months and is added to the principal amount you invested, allowing the interest to compound over the course of months and years. However, you can’t pull out interest and leave the principal. You have to wait until you want to cash out all of it.
Cory: Have you bought any I-Bonds?
Matthew: I have not, mainly because I think inflation will go down and I-Bonds won’t yield as much as they are currently. I think I will be able to find investments that earn more interest than I-Bonds over the next five years.
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Cory: I haven’t bought them either, mainly because I haven’t wanted to invest the capital knowing I wouldn’t have access to it for at least 12 months. I’m pretty confident I wouldn’t need the funds within 12 months, but I don’t think the return is enough for my wife and I to lock up our money for 12 months.
Let’s talk about the overall bond market. Right now, the bond market’s yield curve is sharing some hints about inflation and the overall economy. The yield curve refers to how much interest an investor can earn on bonds with different maturity dates. In a normal economy, bonds that mature in 10 years will pay a higher interest rate than ones that mature in one year, as you’re locking in your capital for a longer period of time. But that’s not the case currently, is it?
Matthew: No, it’s not. We currently have a pretty flat yield curve, with 6-month bonds yielding about the same as 10-year bonds. This means a number of things, including that while the Federal Reserve will raise interest rates, investors don’t expect they will need to raise them by drastic amounts to combat inflation. It appears most analysts and professional investors expect inflation to decline in the not-too-distant future.
Cory: Indeed, and bonds that mature in one or two years are currently yielding more than bonds that mature in 10 years. This is called an inverted yield curve.
Matthew: Yes, and many investors are still choosing to buy a 10-year bond rather than a 2-year bond because they’re concerned we’re going to see low economic growth in the coming years. These investors are choosing the relatively safe harbors of the bond market as they fear a recession could be coming. An inverted yield curve often signals a recession is on the horizon, and these investors want to lock in the highest yields they can.
Cory: Thanks, Matthew. Can you talk about our team’s approach in this environment?
Matthew: Sure. As we see hints that the Federal Reserve could slow their interest rate hikes, or even cut interest rates, we are extending our “ladder.” We’re buying more bonds that mature in the 7-10 year range because we want to lock up the interest bonds are currently paying. If inflation declines and the Fed lowers interest rates, bonds almost certainly will not yield as much as they are today.
Cory: This is a contrast from last year, when we purchased shorter-term bonds because we thought interest rates would continue to rise, taking bond yields with them. Clients should know we can lengthen or shorter this ladder based on current economic conditions. At the moment, we are comfortable extending the duration of the bonds we purchase for clients.
Thanks so much for joining me, Matthew. If you want to learn more about I-Bonds and our bond strategy, please contact me today. You can reach me directly at Cory@falconwealthadvisors.com.
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Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.