I Bond Dilemma: Buy Now, Buy Later, Or Split The Decision?

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Includes: TIP
by: Tipswatch

Summary

Buy before May 1 and get a higher variable rate; buy after May 1 and possibly get a higher fixed rate.

Waiting will cost you short term, and it might take about 4 years to break even.

But I Bond investors are always eager to get a higher fixed rate. Should you divide your purchases this year?

Investors in US Series I Savings Bonds are in an interesting 'limbo' period right now, leading up to the May 1 reset of the I Bond's variable and fixed rates.

It's an interesting decision time because the March inflation number, which was released April 14, established that the I Bond's new variable rate will drop from 2.76% to 1.96% for I Bonds purchased after May 1. Here is how the numbers set up:

One year inflation

The complication is that the I Bond's fixed rate will also be reset on May 1, and it could rise from the current 0.0%. The variable rate changes every six months but the fixed rate stays with the I Bond until it is sold or matures in 30 years. A higher fixed rate is desirable, but there are no guarantees it will rise on May 1.

For years, I've been tracking the I Bond's fixed rate versus the 10-year TIPS real yield, and I believe that's the best indicator of the Treasury's likely decision. According to Treasury's real yield calculations, the 10-year TIPS yield closed today at 0.38%, which I think is 'borderline' for justifying a fixed-rate rise to 0.1%. While I have been saying I think the fixed rate will rise to 0.1%, it could go either way:

  • May 2016. The fixed rate stayed at 0.10% when the 10-year TIPS was yielding 0.30%, lower than today.
  • November 2016. The fixed rate rose to 0.10% when the 10-year TIPS was yielding 0.63%, much higher than today.
  • November 2014. The fixed rate dropped to 0.00% when the 10-year TIPS was yielding 0.42%, higher than today. This one is a bad omen.
  • May 2014. The fixed rate rose to 0.20% when the 10-year TIPS was yielding 0.40%, very close to where it is today. This one was a shocker on the plus side.

We can only guess where the fixed rate will end up May 1. My thinking is that if the 10-year TIPS can hold above 0.40%, the fixed rate will rise to 0.1%. If it falls below 0.25%, it will stay at 0.0%. The range in the middle - where we are now - is a guessing game.

Why would you buy before May 1?

By purchasing an I Bond before May 1, an investor can capture the existing 2.76% variable rate for six months, and then the 1.96% fixed rate for the next six months. A buyer from May to October will get 1.96% for six months, and then six months of the new variable rate to be set on November 1.

It's the first six months that will make the difference, because both purchases will have identical variable rates for six months at a time after that.

So here is the math: An investor who buys the $10,000 yearly limit before May 1 will get a fixed rate of 0.0% and earn $138 in the first six months and then a bit more than $98 the next six months (after compounding is figured in). If he sold after one year, he would earn at least $187 after giving up three month's interest.

This makes for a very strong case for buying before May 1, if you consider this I Bond a short-term investment. You'd earn better than 1.87%, which easily tops any one-year bank CD on the market. If you are looking for a short-term place to park cash, buy your allocation of I Bonds before May 1.

One more point: My thinking on I Bonds is to hold them until maturity unless you: 1) really need the cash, or 2) can roll them over to a much higher fixed rate. So any I Bond with a fixed rate of 0.0% - or 0.1% for that matter - is going to be a target for a future rollover or sale. You probably won't be holding this one long term, and that's another reason to buy before May 1.

Why would you buy after May 1?

This is the 'fixed-rate gamble.' You'd lose out on six months of a higher variable rate, but possibly gain from a higher fixed rate. If the fixed rate rises to 0.1%, you'll earn 2.06% for the first six months, earning you $103, which is $35 less than you'd earn if you bought before May 1. It will take you four years to make up that difference, but after that, you're a winner.

If you see this purchase as a long-term holding, buying after May 1 makes sense. But remember, the fixed rate could stay at 0.0% and you'd be out $40. Oops, but not a life-changer!

But if that fixed rate doesn't rise ...

Let's be real. If the fixed rate doesn't rise on May 1, then you'd be smart to put off purchasing your I Bond allocation until after November 1, when we'll have new variable and fixed rates. Or at least wait until October 13, when the September inflation report will set the new variable rate, and a new period of limbo begins.

Why not split the difference?

This is what I have decided: My wife and I will split our I Bond purchases - $10,000 before May 1 and $10,000 after May 1. If the fixed rate rises on May 1, we will pull the trigger and finish our or 2017 purchases in May. If it doesn't rise, we will wait until mid October to get a better picture of the market.

I know I Bond investors love to fret about the fixed rate, but when you run the numbers the difference between 0.0% and 0.1% or even 0.2% is so far from important that it's ridiculous. It's fun to think about, but not to get into a sweat over.

One thing about I Bond purchases: I know that many people try to time the purchase to the end of the month, because a purchase on April 30 gets full credit for April. However, I'd advise giving TreasuryDirect a few days to handle your order. Don't get too tricky!

I welcome your comments on what you are thinking!

And I'll be writing Thursday afternoon after the 5-year TIPS auction closes. Please follow me to get all the updates.

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.