U.S. Series I Savings Bonds are a boring, ultra-conservative investment that somehow drive many people - including a lot of very wealthy people - to scheme over buying strategies and fret over single basis-point rate swings.
Why is that? Simply this: I Bonds are the only super-safe investment that can guarantee to match inflation while providing tax-deferred earnings, rock-solid deflation protection and a flexible maturity. An I Bond investment can't lose money. Here is what the Treasury says:
They are U.S. Treasury securities backed by the U.S. Government. I Bonds even protect you from the effects of severe deflation - the earnings rate can't go below zero and the redemption value of your I Bonds can't decline.
But there's a catch - the Treasury only allows purchases, through TreasuryDirect, of $10,000 per person per calendar year. (There's also a strategy of receiving up to $5,000 in paper I Bonds as payment for a federal tax refund. This involves too much scheming for me; I don't do it.)
Many investors use I Bonds as a way of pushing predictable, tax-deferred, inflation-protected money into the future (retirement income, for example, or education costs). But to make that strategy work, an investor has to amass a large cache of I Bonds, and the only way to get to that goal is to buy I Bonds every year, up to the limit. So the question each year isn't whether to buy I Bonds, but when to buy I Bonds.
So when should you buy I Bonds in 2017?
I Bonds are presenting investors with an interesting dilemma in January 2017, combining a very favorable but short-term variable rate with a lousy and permanent fixed rate. The current composite rate of 2.76% is an excellent return, but it only applies to the first six months you own the I Bond. Here's how that works:
- The I Bond's fixed rate is currently set at 0.0%, down from 0.1% in October. This rate could be reset - possibly higher - on May 1, 2017, and then again on November 1, 2017. The rate stays with an I Bond through its 30-year maturity.
- The inflation-adjusted variable rate is currently 2.76%, based on non-seasonally adjusted CPI-U from March to September 2016. It will be reset on May 1 based on inflation from September 2016 to March 2017.
- The composite rate is 2.76%, and will be reset on May 1.
Advice: Do nothing right now
There is no reason to buy I Bonds in January - or February or March for that matter - because you can lock in the current favorable variable rate for six months with any purchase through April 30, 2017. So I suggest waiting until April 14, 2017, (8:30 a.m., if you want to mark it on your calendar) to learn details of the March inflation report. At that point, you will know the I Bond's new variable rate for May to November, and you can choose to:
- Buy before April 30, locking in the current 2.76% for six months, and then getting the next variable rate for six months. The fixed rate will stay at 0.0% until you cash out or the I Bond reaches maturity.
- Buy after May 1, locking in the next variable rate for six months. You will get the new fixed rate, as yet undetermined.
- Do nothing, and wait until October 13, 2017, when the September inflation report will be released, setting the November 2017 to April 2018 variable rate.
Unless... you want to make a short-term investment
The Treasury points out that I Bonds "are meant to be long-term investments," but right now, with the variable rate at 2.76%, they are an excellent short-term investment. If you sell an I Bond after one year, you pay a three-month interest penalty. That means with I Bonds currently earning 2.76%, you are guaranteed to get at least 1.38% for a one-year investment, no matter what variable rate is set on May 1.
Can you find a one-year bank CD paying 1.38%? Probably not. Worth the trouble? Probably not. But if this is your strategy, I'd suggest buying near the end of January, because you earn a full month's interest on I Bonds no matter the date you buy them. You can come close to shortening the one-year holding period to 11 months by using this strategy.
The current variable rate is at risk
I track the non-seasonally adjusted inflation numbers each month to follow the status of the I Bond's variable rate. So far, two months into the six-month rate-setting period, the trend isn't good:
Although 'headline' inflation has been steadily rising in recent months, non-seasonally adjusted inflation has actually declined since September. It hasn't been a good beginning for this rate-setting period. These non-seasonal numbers balance out over a year, but at this point, the variable rate of 2.76% looks at risk for the next reset.
The current fixed rate is too low
The Treasury set the I Bond's current fixed rate at 0.0% on November 1, when the real yield on a 10-year Treasury Inflation-Protected Security was 0.11%. On Oct. 16, I predicted that could happen, given the very low real yields at the time.
But the Treasury's decision came just a week before Donald Trump was elected U.S. president, shaking up the bond market. The Treasury currently estimates a 10-year TIPS real yield at 0.46%, which could justify an I Bond fixed rate of 0.1%. For example, on May 1, 2016, the Treasury set the fixed rate at 0.1% when the 10-year TIPS was yielding 0.30%.
Are you delaying an I Bond purchase because you want a higher fixed rate? That could be a good move.
The showdown: Variable rate versus fixed rate
This isn't a contest. The fixed rate is the most important factor in any long-term I Bond purchase. The fixed rate stays with the I Bond for 30 years, and it is your actual real yield above inflation. A fixed rate of 0.0% will match inflation, but can't beat it. When you sell your I Bond, taxes will cut into your gain.
When viewing an I Bond as a long-term investment, consider a higher fixed rate your No. 1 priority. If you have I Bond holdings with a 0.0% fixed rate, those can be targets for future sales, while retaining the higher fixed rates as long as you can.
However, as we approach the May 1 rate reset, watch that variable rate. If it barely climbs above 0.0%, then an I Bond purchase with a fixed rate at 0.0% might make sense. On a $10,000 investment, you'd earn $138 in six months, equal to the earnings of nearly 14 years of a 0.1% fixed rate. I don't see this as likely, however.
With these strategies in mind, 2017 is going to be a waiting game. Watch the variable rate; hope for a higher fixed rate.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.