With each new year, dedicated investors in U.S. Series I Savings Bonds face the inevitable question: When to buy? And this year, they might face an additional question: Should I buy?
U.S. Series I Savings Bonds are very safe, very conservative investments that accurately track and currently out-perform U.S. inflation, as defined by the CPI-U, the Consumer Price Index for All Urban Consumers. Although I Bonds offer zero chance at future riches, they are coveted by many investors - including some very wealthy investors - as a way to push inflation-protected, tax-deferred money into the future. This investment is all about capital preservation, and makes sense as part of an overall investment portfolio that mixes safety and risk.
For more on I Bonds, read my article: 'Why Would Anyone Buy Inflation-Protected Investments?'
But the catch with I Bonds is that the U.S. Treasury limits purchases to $10,000 per person per year. Each January, the calendar resets, and investors again face the question: When to buy?
I Bonds combine a fixed rate (currently 0.50%) that remains with the investment forever, and an inflation-adjusted variable rate (currently 2.32%) that changes on May 1 and November 1 each year. This creates a current composite rate of 2.83% annualized for purchases through April 30.
The No. 1 priority for I Bond investors is to maximize the fixed rate, which is equivalent to the "real yield to maturity" of Treasury Inflation-Protected Securities. The fixed rate remains until the I Bond matures or is redeemed. The No. 2 priority, but less important, is to maximize the inflation-adjusted rate, which changes every six months for all I Bonds.
Does it make sense to buy I Bonds in 2019?
For practical purposes, an I Bond can be considered equivalent to a 5-year TIPS, because the I Bond can be redeemed after 5 years with no penalty. (Redemptions after 1 year and up to 5 years carry a three-month interest penalty.)
As of Friday, the U.S. Treasury estimates a full-term 5-year TIPS would yield 0.91% above inflation, or 41 basis points higher than the I Bond's current fixed rate. That spread has declined 21 basis points since December 20, but it still has many investors thinking: Buy 5-year TIPS instead of I Bonds.
But keep in mind that I Bonds have some important benefits over TIPS: tax-deferred interest, much better deflation protection, 100% reinvested earnings and a flexible maturity date. Generally, until TIPS real yields begin approaching 0.0%, I Bonds will always have a lower yield. Here's a chart tracking the 5-year real yield of TIPS since 2009, compared to the 0.0% mark (the lowest an I Bond can go) and the current 0.5% fixed rate:
(Source: St. Louis Federal Reserve)
For much of this time period, when the 5-year TIPS real yield fell well below zero, I Bonds were a screaming buy versus TIPS. Today, the equation has shifted toward the 5-year TIPS.
My opinion: A spread of 41 basis points is reasonable and I Bonds with a fixed rate of 0.50% remain attractive in 2019, at this point in time. I plan to be a buyer of I Bonds in 2019, unless conditions change. And I would still be a buyer of 5-year TIPS at these levels.
But I won't be rushing to make an I Bond purchase in January.
Mark your calendars: April 10, 2019
Because the current fixed rate of 0.50% is locked in for purchases up to April 30, I advise I Bond investors to sit on the sidelines at least until 8:30 a.m. on April 10, 2019, when the Bureau of Labor Statistics will release the March 2019 inflation report. That report will set in stone the I Bond's next variable rate, which goes into effect May 1. Here is how those numbers are shaping up:
So far, this isn't pretty, and it's possible that our current deflationary swoon could continue for months with gasoline prices falling sharply. On April 10, investors will know the new variable rate and will have 20 days to decide: Buy before April 30, buy in May, or skip it.
Also, in that 20-day "limbo period" period, we can take a look at the current 5- and 10-year TIPS real yields to handicap the likelihood that the Treasury will raise or lower the I Bond's fixed rate on May 1. If a higher fixed rate looks likely, investors should hold off on purchases, even if the variable rate will be lower. However, the current data do not suggest a higher fixed rate is coming:
The real yield spreads have declined for both the 5- and 10-year TIPS since the November 1 rate reset. At this point, I'd say there is zero chance the Treasury would raise the I Bond fixed rate on May 1. A lot can change in the next four months, but if this trend continues, I'd be a buyer of I Bonds before the May 1 reset.
A second limbo period begins October 10
The year's second 20-day investment opening begins at 8:30 a.m. on October 10, 2019, when the BLS releases the September 2019 inflation report, setting in stone the variable rate to go into effect November 1. Investors will again have a 20-day period to decide to buy before or after November 1, or to skip the purchase.
In 2018, investors who waited until November 1 were rewarded with a 0.50% fixed rate, the highest in 10 years.
Unusual advice: Redeem I Bonds?
Because of the annual purchase cap, I rarely advise I Bond investors to consider redeeming their holdings, unless they need the cash. The idea is to build up a large amount of tax-deferred, inflation-protected cash. But because I Bonds had fixed rates of 0.0% for many purchases from 2010 through 2017, those low-yielding purchases could be targets for redeeming and reinvesting at 0.50%.
Which I Bonds should you target? Any I Bond purchased from 2010 to 2014 with a fixed rate of 0.0% and held for a full 5 years, to avoid the three-month interest penalty.
Keep in mind that after you redeem an I Bond, you will face federal taxes on the earnings. Also, you will still be under the $10,000 a year per person purchase limit, so your overall holdings will not increase in 2019 if you follow this strategy.
This strategy would be especially wise for a past I Bond investor who is planning to skip a purchase in 2019. Redeem and replace, and your overall holdings will remain stable, but your return would be higher.
In my case, I am still holding some I Bonds purchased in 2011 and 2017 with fixed rates of 0.0%. The 2011 purchases are begging to be redeemed, but the 2017 purchases aren't, because of the interest penalty.
A word of warning: Get prepared before you go to Treasury Direct to redeem your purchases. It's difficult to tell the fixed rate in the Treasury Direct lists, which shows the current composite rate. Check your records for purchase dates and fixed rates, and here's a hint: If the current composite rate is 2.22%, the fixed rate is definitely 0.0%. (Variable rates kick in at different times, depending on when you purchased the I Bond.) A composite rate of 2.32% might mean the I Bond has a fixed rate of 0.0%, but possibly not, depending on the purchase date.
I still advocate purchasing I Bonds (and TIPS, of course) as part of an overall investment strategy that includes an allocation for very safe, inflation-protected savings. I Bonds with a fixed rate of 0.50% remain attractive, and I plan to be an investor in 2019, either with a new purchase or a redeem-and-purchase strategy.
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.
Additional disclosure: I own individual TIPS, but no mutual funds.