Inflation has become a major concern for investors after the annual inflation rate rose to 6.8% in November.
The stock market has historically been a good hedge against inflation, but most investors keep part of their portfolio in fixed income as a buffer against stock market fluctuations. Returns on fixed-income investments have been earning significantly less than inflation with money market accounts and certificates of deposit earning between zero and 0.5%.
Until inflation returns to a more reasonable level, I bonds may be an excellent option to keep pace with high inflation. I bonds issued between November 2021 and April 2022 are paying an annual rate of 7.12%. I bonds are securities issued by the U.S. government that pay two interest components — a fixed rate that remains the same for the life of the bond and a variable rate based on inflation rate that is adjusted every six months. The variable rate is based on the Consumer Price Index for all Urban Consumers (CPI-U). The current fixed rate is zero, and the current variable rate is 7.12%.
I bonds have a maturity of 30 years, but you are not required to hold them until maturity. You must hold them for at least 12 months, and if you sell them after 12 months but before five years you forfeit the last three months of interest. This may seem restrictive, but inflation is unlikely to drop dramatically over the next 12 months. If inflation falls significantly during the next five years, it may be time to sell the bonds and then the loss of three months in interest will have less impact.
Due to the required holding period of 12 months, I bonds are not a good option for your emergency fund — which should be readily accessible.
An individual is limited to an electronic purchase of up to $10,000 in I bonds in a calendar year. A couple can electronically buy a total of $20,000 a year. With year-end approaching, you can purchase $10,000 by Dec. 31 and another $10,000 in January. A couple can purchase a total of $40,000 in I bonds between now and the first week of January. If you receive a tax refund, you can use it to buy another $5,000 in paper I bonds.
I bonds can be electronically purchased by establishing an account at Treasury Direct, www.treasurydirect.gov. Once the account is created, you can transfer money from your bank account to purchase the bonds.
Interest on I bonds is compounded semi-annually, and the value of your bonds increase on the first of every month. The interest is subject to federal tax but not state or local tax. The interest is tax free if used for qualified education expenses. Interest can be reported to the IRS on an annual basis, or when you sell the bonds.
Jane Young, a fee-only certified financial planner, can be reached at firstname.lastname@example.org.
Jane Young is a fee-only certified financial planner and can be reached at email@example.com