Seeking Alpha

I-Bond Investors: Here's A Buying Guide For 2020

|
Includes: TIP
by: Tipswatch
Tipswatch
Bonds, long-term horizon, I Bonds, TIPS
Summary

The I-Bond's current fixed rate of 0.20% (essentially, its "real yield") means it remains the most attractive inflation-protected investment.

I recommend waiting until April 10 to make an I-Bond investment decision, because we will then know the future variable rate.

Most likely, the fixed rate of 0.20% will be the highest we see in 2020, but a lot can change in the next 12 months.

Series I Savings Bonds

After a year of deep declines in yields for Treasury investments, here's something to remember: U.S. Series I Savings Bonds remain a relevant investment.

I-Bonds are very safe, very conservative investments that accurately track and currently outperform U.S. inflation, as defined by the CPI-U, the Consumer Price Index for All Urban Consumers.

And as inflation fears begin rumbling through the economy, I-Bonds become even more important, because they remain the best inflation-protected investment available, with guaranteed above-inflation yields that top those of 5- and 10-year Treasury Inflation-Protected Securities. For example:

  • I-Bonds purchased through April 30 carry a fixed rate of 0.20%, equivalent to the "real yield to maturity" of a TIPS. That is down 30 basis points in the past year.
  • A 5-year TIPS currently has a real yield of -0.10%, down 98 basis points from a year ago and 30 basis points lower than an I-Bond.
  • A 10-year TIPS currently has a real yield of 0.03%, down 85 basis points from a year ago and 17 basis points lower than an I-Bond.

Here's a chart comparing these real yields over the last seven months. Because the I-Bond's fixed rate is set for six-month periods, it is not subject to market fluctuations. It is reset by the Treasury on May 1 and November 1 each year.

Real yield comparison

When the I-Bond's fixed rate is higher than the real yield of a 5- and 10-year TIPS - as is true now - it is clearly the superior investment. Why?

In "normal" times, an I-Bond has a real yield about 50 to 75 basis points lower than a 10-year TIPS. Now it has a 17 basis point advantage. That's significant, because the I-Bond:

  • Has a flexible maturity. It can be redeemed after one year for a three-month interest penalty or after five years with no penalty. Or, if held, it will continue paying inflation-adjusted interest for 30 years.
  • Pays tax-deferred interest. No federal income tax is due until the I-Bond is redeemed, a big advantage over a TIPS, where inflation accruals are taxed in the current year. This tax treatment makes the I-Bond similar to a traditional IRA, but it is not subject to Required Minimum Distributions.
  • Has rock-solid deflation protection. Even in times of severe deflation, an I-Bond will never lose any of its accumulated value. This isn't true for a TIPS, where accrued principal falls in reaction to a deflationary month.
  • Is a simpler investment. I-Bonds don't go up and down in "market" value. They simply pay inflation-adjusted interest, which accumulates and compounds over time. When you redeem them, you know exactly what you will receive. TIPS rise and fall with market swings until final maturity.

One negative of investing in I-Bonds is that the Treasury limits purchases to $10,000 per person per year in electronic form, through Treasury Direct. (You can also get up to $5,000 a year in paper I-Bonds in lieu of a federal income tax refund.)

Although I-Bonds offer zero chance of 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 designed for capital preservation.

To build a meaningful cache of I-Bonds, investors pretty much have to buy them every year, up to the $10,000 limit. So, yes, I am recommending that you purchase I-Bonds in 2020. But the key question is: When?

Focus on the fixed rate

I-Bonds earn a composite interest rate that combines the permanent fixed rate with an inflation-adjusted variable rate that changes every six months to match U.S. inflation. For I-Bonds purchased through April, this is the simplified yield equation:

Fixed rate (0.20%) + semiannual inflation rate (1.01% x 2 = 2.02%) equals the current composite rate of 2.22%.

I have found that the semiannual inflation rate - which is reset in May and November - accurately tracks official U.S. inflation, so the fixed rate is the most important factor for I-Bond investors. The higher the fixed rate, the better. So I-Bond investors should look to maximize the fixed rate, and that means being patient as we head into 2020.

A key date: April 10, 2020

On April 10 at 8:30 a.m. ET, the Bureau of Labor Statistics will issue its March inflation report, which will be the final piece of data needed to determine the I-Bond's new inflation-adjusted variable rate. I track this inflation data each month to size up the likely trend for I-Bonds:

I Bond inflation tracking

On April 10, investors will know the new variable rate and have a fairly good indication of where the I-Bond's fixed rate could be headed, based on current real yields for 5- and 10-year TIPS. Then investors have 20 days to decide: Buy before April 30, buy in May, or skip it.

Unless things change dramatically, I am guessing that the current fixed rate of 0.20% is as good as it will get in 2020. So I am also guessing an investment before April 30 will make the most sense. If you prefer to make the investment in January, I can't argue with that. But there is little harm in waiting until April 10, when the next six months of returns will be much more clear.

Another buying period begins Oct. 13, 2020

The BLS will issue its September inflation report October 13 at 8:30 a.m. ET, providing the final piece of data needed to determine the new variable rate to go into effect on November 1. At that point, investors who passed on the April purchase will have 18 days to decide to buy in October or wait until November.

The variable rate can be a factor in this buying decision. If the variable rate is increasing dramatically, and the fixed rate looks likely to hold, then waiting makes sense. Some investors view I-Bonds as short-term investments, planning to sell after one year despite the three-month interest penalty. If the variable rate is high enough versus current one-year bank CDs, this makes sense.

And some investors will prefer to space their $10,000 in purchases across the year, possibly buying $5,000 before April 30, and the other $5,000 later in the year. As long as the fixed rate holds or rises, this strategy works.

Recommendation

I suggest that you prepare to purchase I-Bonds, up to the limit, in the early months of 2020 to take advantage of the 0.2% fixed rate. Waiting until April 10 makes sense, because you will then know the future inflation-adjusted rate, and have a better idea of the future fixed rate.

Most likely, however, the fixed rate of 0.20% will be the highest we see in 2020, and so buying early in the year, even in January, can be justified.

The Federal Reserve does not look likely to raise its federal funds rate this year in the months leading to a major U.S. election. My only caution is that if inflation spikes higher this year, longer-term bond yields are likely to rise, and TIPS real yields would climb with them.

At current real yield levels, TIPS are not preferable to I-Bonds. But if real yields climb, TIPS will again be worth considering.

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: David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges.