How do you get guaranteed earnings of 6.7% or more on your money without any risk? Although it sounds very good to be true, that is exactly the opportunity that will be given on November 1st. Investment? Series I Saving Bonds.
IBonds is a 30-year bond issued by the US Treasury, available to anyone opening a free Treasury Direct account. These bonds are the ultimate risk free asset. Supported by the full trust and credit of the US government, they have minimal credit risk. They also provide inflation protection, as their yields are on the inflation index.
I Bond yield is the sum of two factors: a fixed rate and an inflation rate. The fixed rate is set at the time of purchase, and remains fixed for the life of the bond. It is currently 0%, so you can effectively ignore it.
The inflation rate of production adjusts twice a year – the first business days of May and November. The half-yearly inflation rate of I Bonds currently sold is 1.77%. It determines the interest earned over the next six months. Double it and you will get the annual percentage rate (APR) of the bond, which will be 3.54%.
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While 3.54% isn’t bad, the new rate in November is all but certain Lots Superior. My guess is that the bonds I have issued will carry a high yield of at least 6.7% and possibly up to 7.8%. Let me explain.
The rate of inflation is based on the consumer price index for all urban consumers, which I will simply call the CPI. The November rate will be based on a percentage change in CPI from March to September this year. We already know the CPI number for March, which was 264.877. The September CPI will not be released until October 13, but the August number was 273.567.
The CPI is not expected to change in September সাম recent trends are most likely not given-the six-month percentage change will be 3.28%. This corresponds to an APR of 6.56%. The effective annual rate you will earn 6.67%, since I do half the compound bond.
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Most likely, the CPI level in September will be higher than in August. How much? The average monthly increase in CPI is 0.55% year-to-date. If this growth rate is increased, the CPI for September will be 275.072, which is related to the half-yearly inflation rate of 3.85%. The corresponding effective annual rate for I bonds will be 7.85%. It’s not too disgusting, especially considering this return is risk-free.
Of course, the rate will only apply for six months. In May 2022, the rate will be adjusted again. If the Fed’s transient thesis is correct and inflation declines next year, I bond interest rates will fall. On the other hand, if inflation continues or accelerates, I bond yields will remain high and money-market funds and savings accounts will outperform.
Another bonus: Unlike TIPS, or Treasury inflation-protected securities, I bonds are protected against capital losses. Upon entering a savings account, the original value of the I bond may only increase. In a situation where inflation is negative, the rate of inflation in I bonds can never go below zero.
Eye bonds must be held for a minimum of one year after purchase. If you redeem an I bond before the age of five, you will lose interest for the last three months. Assuming an interest rate of 6.67%, selling early will reduce your return by 5% for the last 12 months.
How many bonds can you buy? The annual limit per person is $ 10,000. This means that a married couple with two children can buy up to a total of $ 40,000. If that family has a trust, an additional $ 10,000 can be purchased in the name of the trust, for I 50,000 per year for an I bond. Remember, if you bought an I bond for a child through a custody account, it constitutes an irreplaceable gift.
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I also enjoy favorable tax treatment on bonds. Interest is subject to federal income tax, but exempt from state and local taxes. You can suspend reporting interest on your federal tax return until you have cash or bond maturity on your bond. If you hold an I bond for maturity, it is a 30-year tax-deferred growth. Speaking of taxes, you can buy up to an additional 5,000 Paper I bond every year using your federal tax refund.
If you are considering an I bond, I would recommend waiting until November 1, when the interest rate will be reset to a much higher level. Just don’t expect most advisors to recommend them. I bonds are only available through TreasuryDirect.gov – commission-free available or when you file your tax return. As such, your advisor can make you a small profit by investing in these wonderful bonds.
This column was first published in Humble Dollars. It has been republished with permission.
John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available in both a free PDF and a Kindle version. Follow John on Twitter T John Tilim And see his previous articles.