What Should I Do with My I Bonds Now?  Buy, Sell or Hold?

Over the past year, we have witnessed the fastest rise of short-term interest rates since the early 1980s.  This week, the Federal Reserve set the target range for its benchmark short-term interest rate (the federal funds rate) at 5% to 5.25%.  A year ago, that benchmark rate was below 1%.  The main reason that the Fed has been raising rates is to combat inflation, which surged in 2021 and 2022. One consequence of the rapid rise in inflation preceding this hike in interest rates was that it made a type of savings bond offered by the federal government (Series I bonds) extremely attractive for a short period of time.  The purpose of I bonds is to protect investors from inflation risk.  Their return consists of a fixed interest rate and a rate that changes with inflation.  The faster the increase in inflation, the higher the variable rate on I bonds.

The Lure.  While the fixed interest rate of I bonds has hovered near 0% for more than a decade, the inflation adjustment rate jumped significantly in late 2021 and 2022— leading the combined rate on I bonds to rise much more swiftly than the return on other “safe investments” (e.g. interest rates on savings accounts or yield on money market funds).  In May to November 2022, I bonds offered annual interest rates over 9.5% with essentially no risk.  I bonds do have their limitations and drawbacks, however, which are now causing I bonds holders to question what to do next.

The Drawbacks.  First, individual investors can only purchase $10k of electronic I bonds per year.  (They can purchase an additional $5k if they are willing to buy paper I bonds as well.)  So, even at their peak, the benefits of I bonds were limited by this investment cap.  Second, I bonds must be held for more than a year, and if they are not held for at least 5 years, investors lose the last 3 months of interest when they cash in the bonds.  Third, the fixed rate portion of the I bond return is set at the discretion of the Treasury Department and remains static for the life of the loan.  As of May 1, the fixed rate interest on I bonds has now been set at 0.90%.

What To Do Now.  For the time period of November 2022 to May 2023, I bond holders earned annual interest of at least 6.48% (depending on when they purchased their bonds).  This exceeds the interest offered on other safe investments during that timeframe.  Starting May 1, however, this rate has dropped.  New I bond purchases will now earn a combined rate of 4.30%, and the interest rate on most I bonds purchased in 2021 and 2022 will drop to 3.38% over the coming months (since their fixed rate interest is zero).  For the first time in two years, the combined rate on I bonds has now fallen below the return offered on many savings accounts and money market mutual funds.  (Online savings banks such as Discover, Ally Bank, and Marcus are offering 3.75% interest or higher while many money market mutual funds are offering over 4.50% current yield.)

Clearly, I bonds are no longer the most attractive option for short-term returns, so we do not recommend purchasing more I bonds now for that purpose.  If you purchased I bonds over the last couple years as a short-term measure (e.g. to obtain higher yield on your emergency fund savings), we suggest waiting three more months after your combined rate drops to 3.38% (to avoid losing the higher interest accrued prior to the rate drop), then selling the I bonds and transferring the funds to an online savings bank or money market fund with a more competitive rate. (For a specific month-by-month schedule based on the date that you purchased your I bonds, check out the charts in this article from Keil Partners in Wisconsin.)

A recent article in the Wall Street Journal suggested that even though I bonds now hold less appeal for short-term returns, they could still be useful as a long-term investment to hedge against inflation.  From our perspective, that goal is mainly achieved by the stock portion of your portfolio, which beats inflation over the long term, so I bonds are not a necessary part of an investment portfolio.  Historical I bond rates are reasonably attractive when considering the returns of intermediate-term, high-quality bond funds over the past couple of decades though.  If investors are interested in managing an I bond portfolio on Treasury Direct as a portion of their overall bond portfolio, there would be some advantages, including the fact that savings bond interest is exempt from state and local taxes.  The annual $10k cap on I bond purchases, however, does limit the extent that investors can use this strategy and makes the potential benefits not worth the effort for many investors who prefer a set-it-and-forget-it approach.

If you hold I bonds and have been wondering what to do with them, please do not hesitate to call or email so we can discuss your options.