- Series I Savings Bonds purchased through April 30 will have a permanent "real yield" of 0.2%, well above TIPS yields of any maturity.
- I Bonds carry many benefits over TIPS, including tax-deferred interest and rock-solid deflation protection.
- Another Savings Bond, the EE Bond, is also very attractive under current terms, offering a 3.5% return for anyone who can hold it 20 years.
I've been writing about TIPS and I Bonds for nearly 10 years, and there have few times when I Bonds have reached the level of a SCREAMING BUY. Right now, in March 2020, it's time to say: "I Bonds are a screaming buy."
I've been pounding the table for I Bonds in recent months, often calling them the best inflation-protected investment in the world. But we've now reached a point where I Bonds are amazingly superior to similar very safe investments.
Normally, I would suggest that investors wait until closer to the May 1 reset of the I Bond's fixed rate to make a purchase, but that is clearly no longer an issue. The fixed rate has zero chance of going higher than the current 0.2% and about a 99% chance of dropping to 0.0%. So clearly, the case can be made to buy I Bonds in March, or April, but definitely before the fixed rate resets on May 1. And buy up to the full limit of $10,000 per person per year.
A primer on Savings Bonds
Barron's columnist Randall Forsyth wrote an excellent (and accurate) column this week extolling U.S. Savings Bonds as a "secret weapon for small investors." I noted "accurate" because it is rare to see these often-ridiculed investments -- I Bonds and EE Bonds -- correctly explained. He noted:
Savings bonds come in two varieties, series EE and series I. Their stated interest rates are trivial—0.10% and 0.20%, respectively. But both come with kickers that make them super deals.
Unfortunately, Forsyth's column is behind the Barron's paywall and a lot of people won't be able to read it. So here's some basic information.
Understanding I Bonds. A Series I Savings Bond is a Treasury security that earns interest based on combining a fixed rate and an inflation rate.
- The fixed rate will never change. So if you buy an I Bond today with a fixed rate of 0.2%, it will continue to have a 0.2% fixed rate for the life of the bond. I Bonds purchased back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.
- The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 2.02% annualized. It will adjust again on May 1, 2020, for all I Bonds, no matter when they were purchased. (The effective start date of the new interest rate varies depending on the month you bought the I Bond, a Treasury oddity.)
The combination of the fixed rate and inflation-adjusted rate creates the I Bond's composite interest rate, which is currently 2.22%. An I Bond bought today will earn 2.22% (annualized) for six months and then get a new composite rate every six months for its 30-year term.
Do I Bonds accurately track U.S. inflation? Yes. And so an I Bond purchased today will earn a "real yield" of 0.2% ... meaning a yield 0.2% higher than inflation.
Why are I Bonds an attractive investment?
- First, I Bonds are very conservative and safe. Your principal is guaranteed by the U.S. Treasury and it will never decline, ever. If inflation falls to below zero, the inflation-adjusted rate will fall to zero, but not below zero.
- I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.
- I Bonds protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate.
- I Bonds allow you to defer federal income taxes until you redeem them, so you pay zero in taxes until they are sold. Also, there are no state income taxes on I Bonds.
- I Bonds aren't traded on a secondary market and so they they don't go up and down in value with changes in interest rates. Their value is simply your original purchase, plus accrued interest, and that total can never go down.
One downside to I Bonds is that the Treasury limits purchases in electronic form to $10,000 per person per calendar year. (Plus there is an option to get $5,000 in paper I Bonds in lieu of a federal income tax refund.) So I Bonds are directed at small investors, but it is possible to accumulate a large cache of I Bonds by purchasing them, up to the limit, ever year.
Understanding EE Bonds. While I Bonds are an inflation-adjusted investment, EE Bonds are nominal investment, earning a set rate of interest over time. The Treasury says:
The annual interest rate for EE Bonds issued from November 1, 2019 through April 30, 2020, is 0.10%.
Most media reports on EE Bonds leave it at that. You earn 0.1% on your money, for 30 years. Obviously, that is horrible. But there is more to EE Bonds than that, a big "kicker" as Forsyth notes in his Barron's column:
For Series EE bonds, the Treasury makes a one-time adjustment to twice their face value on the 20th anniversary of their issue date, as the TreasuryDirect.gov website explains. That means EE bonds yield 3.53%—more than 200 basis points (two percentage points) above the 30-year Treasury bond, which was trading late this past week at 1.45%. To double your money at the yield of a 10-year Treasury would take about 100 years.
A Series EE Savings Bond is an appropriate investment only for people who are absolutely sure they can hold the bond for 20 years, then redeem it. An EE Bond earns 0.1% for 19 years, 11 months. Then it doubles in value. After it doubles, it again earns 0.1% for another 10 years. So EE Bonds should be held exactly 20 years, then redeemed.
EE Bonds are an ideal investment for a 45-year-old investor planning to retire at age 65. A couple could purchase $20,000 a year, beginning at age 45, and then begin redeeming $40,000 a year at age 65. This is a "do-it-yourself-annuity" plan laid out by Mel Lindauer of the Bogleheads forum in an article for Forbes:
Indeed, I do feel that it's possible for an investor to build a 20 or 30-year risk-free annuity without involving an insurance company. ... And, unlike with a life benefit Single Premium Immediate Annuity where the money goes to the insurance company at death, if the couple with the EE Bond annuity ladder died prior to redeeming all of the bonds at age 95, the remaining unredeemed EE Bonds would go to their heirs.
EE Bonds are also subject to the $10,000 per person per year purchase limit, and there is no option to receive paper EE Bonds in lieu of a tax refund. The fixed rate of 0.1% will be reset on May 1, but is highly likely to remain at 0.1%. So there is no urgent need to invest quickly in EE Bonds. (I suppose the Treasury could lengthen the 20-year doubling period, making EE Bonds much less attractive. I think that is unlikely.)
Why I Bonds are so attractive
My focus today is on I Bonds, because the fixed rate is very likely to fall on May 1 from the 0.2% level. So investors should plan on making a "full investment" before April 30. Let's go back to the key question; "Why are I Bonds a screaming buy?"
The turmoil in global financial markets -- caused by the spread of the COVID-19 virus -- has pushed stock prices sharply lower, and Treasury prices sharply higher as investors seek a safe haven. This means that both real and nominal yields for U.S. Treasurys have plummeted to record-low levels.
And there's where the Series I Savings Bond has a key advantage: Its fixed rate truly is fixed at 0.2% and won't change for new purchases until the May 1 reset. As yields for Treasury Inflation-Protected Securities have plummeted, the I Bond has been building a higher and higher advantage versus TIPS. With a 30-year TIPS now earning a real yield of -0.22%, the I Bond has a stunning 42-basis-point advantage. And this is for an investment with tax-deferred interest and much better deflation protection.
Here is how the I Bond and TIPS real yields have compared since the I Bond's last rate reset, in November 2019, showing the remarkable drop in TIPS yields as the I Bond fixed rate remained stable:
The I Bond was competitive back in November 2019 versus TIPS with maturities of 10 years or less. (I strongly favor I Bonds over TIPS when this happens.) But now, that 0.2% fixed rate is towering over the TIPS competition. Investors seeking inflation protection should invest their first $10,000 in I Bonds before considering a TIPS purchase, even in a TIPS mutual fund or ETF.
How do nominal yields compare?
What will happen if inflation lingers at a fairly slow rate of 1.5% to 2.0% over the next 10 to 20 years? Will an I Bond under-perform nominal investments like U.S. Treasury bills or bonds? Probably not.
Yields on U.S. Treasurys are currently so low that their returns look highly likely to lag official U.S. inflation in coming years. That means I Bonds, which will out-perform inflation by 0.2%, are likely to be the better investment. Some numbers:
Through all inflation scenarios of 1.5% or higher, the I Bond will out-perform all nominal or inflation-adjusted U.S. Treasurys at current yields, no matter the term. An insured 5-year bank CD (still available at 2.1%), will out-perform the I Bond if inflation averages 1.8% or less in coming years. Otherwise, at higher inflation rates, the I Bond will offer a return equal to or higher than the bank CD, with deferred interest and no state income taxes.
The oddball alternative is the EE Savings Bond, which crushes the I Bond (and all other Treasurys and bank CDs) at lower inflation rates. The I Bond won't equal the return of the EE Bond until inflation averages at least 3.3%. That doesn't look likely in the short term, but over the next 20 years, who knows?
Both forms of U.S. Savings Bonds -- I Bonds and EE Bonds -- are exceptionally attractive investments right now. The I Bond is clearly the best very safe inflation-protected investment in the world. And the EE Bond is clearly the best very safe nominal investment, if held for 20 years.
These investments are designed for small-scale investors, are simple to purchase in electronic form at Treasury Direct and are very safe. Investors willing to invest every year can amass a meaningful allocation in these bonds.
And today, in March 2020, the time is right to buy.
This article was written by
Analyst’s 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.
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.
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