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I Bonds Explained: What are Series I Savings Bonds? - YouTube
Channel: Healthy, Wealthy, and Wise
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so a year ago around this time i put out
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a video on inflation and talked about
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using treasury inflation protective
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securities or more commonly referred to
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as tips as one way to hedge against it
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in that video i also talked about
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traditional bonds in general and how
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they differ from tips
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today i'm going to talk more about bonds
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this time specifically series i bonds as
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another way to hedge against inflation
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i'll tell you what they are
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why you might consider them it may be
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reasons why you shouldn't plus if you
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feel they're right for you i'll tell you
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how you can get them it's a little more
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limited than with other types of
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investments
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but real quick i want to first welcome
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you to healthy wealthy and wise we're
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talking about our financial wellness and
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how to achieve it is my top focus
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my name is kevin and on this channel i
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share my experiences and the strategies
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i've used in my over 25 years of diy
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investing
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and now that we're having the highest
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levels of inflation that i've seen in my
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adult life
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talking about inflation hedges makes
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sense
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as i talked about inflation last spring
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in the tips video i mentioned how the
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federal reserve rate was essentially at
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zero percent at the time in that
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eventually the rates would begin to rise
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to tamp down inflation which was already
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starting up
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well it really ramped up and now after
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the highest rates of inflation in 40
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years
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that cycle of rate hikes has begun this
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year
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and with interest rates already going up
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with more to come the era of cheap
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financing and loans is over and this
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higher interest rate environment has
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been a huge factor in pushing the
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overall stock market down
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hammering those highly leveraged growth
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stocks particularly hard resulting in
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many of us having seen our stock funds
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drop significantly in value since the
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beginning of the year
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so with all the major stock indices down
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with more rate hikes on the way that
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will only keep pressuring stock prices
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everyone's asking where can they safely
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put their money
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the one thing we should realize is that
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a basic bank savings account isn't
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really all that safe in an inflationary
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period
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yes your principal is protected which
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there's something to be said for that if
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you'll be needing your money soon
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however the reason that a bank savings
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account is not really all that safe is
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that the interest you're paid by the
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bank on your money is still very low
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in fact well below the rate of inflation
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and that's important to consider because
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inflation erodes our purchasing power
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meaning that we can buy for 100 today
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might cost 110 or more next year
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and yet the interest you receive for
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keeping your 100 in the bank for that
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entire year might only net you about 50
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cents or so
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so even though your principal is safe
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the purchasing power of it goes down so
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in a way you're losing money
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put another way your money is basically
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becoming less valuable because it's not
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keeping up with the rate inflation which
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means that the cost increases on things
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you buy is going up faster than your
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money is growing in a bank account
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because the interest rate is so low
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so what can you do with your money to
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help it grow at a level that matches
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inflation
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well tips is one option as i said at the
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beginning of this video we've already
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talked about them on this channel in
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another video so if you missed it you
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might want to check that one out i'll
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link it for you in the description
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another option in the focus of this
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video is investing in serious eye bonds
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or just i bonds
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i-bonds are inflation-adjusted u.s
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savings bonds
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as the name implies an i-bond is
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designed to have a rate that adjusts by
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either increasing or decreasing along
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with the rate of inflation
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how it works to keep it simple is that
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the i-bond actually has two rate
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components
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one component that is fixed and another
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one that is variable
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let's talk about the fixed component
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first
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the fixed rate component of an i bond
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stays the same over the length of the
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bond which is for the entire 30 years
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that interest can accrue on it after
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it's issued
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this rate is unsurprisingly pretty low
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but you might be surprised to know it's
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actually been a zero percent for the
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past two years
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needless to say nobody is buying an
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i-bond at this time based on the fixed
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rate of zero percent over the next 30
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years
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it's the second variable rate component
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that is drawing all the interest in i
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bonds right now
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this is called the inflation rate of the
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bond
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the inflation rate is updated every six
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months based on changes in the
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non-seasonally adjusted cpi which stands
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for the consumer price index for all
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urban consumers for all items and this
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measure includes food and energy
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this update to the inflation rate occurs
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two times per year
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on the first business day of may and on
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the first business day of november
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when we are in an inflationary period as
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we currently are in now the inflation
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rate of the bond is positive meaning you
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accrue interest
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now in periods of deflation where prices
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are dropping and the cpi is negative the
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treasury limits the combined rates of
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the bond to zero so you don't have to
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worry about a situation where you're
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losing money by holding the bond you
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just won't be earning any
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so as of this recording we're now in may
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of 2022 and the semi-annual inflation
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rate was just recently set at 4.81
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percent
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and the formula for calculating the
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composite rate or the combination of the
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fixed and variable rates is the fixed
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rate plus two times the semi-annual
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inflation rate plus the fixed rate times
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the semi-annual inflation rate
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so using that math which is zero plus
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two times zero point zero four eight one
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plus zero times zero point 0.0481 the
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composite rate comes to 9.62 percent
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that means that any i bond bought within
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this time period may through the end of
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october will have interest accrued at
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this rate monthly
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now what's important to know here is
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that if you bought an i-bond at any time
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during this time period your i-bond will
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pay you at that rate for the next six
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months whether you bought it in may when
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the new rate took effect or even if you
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bought it in october at the end of the
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period
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after those six months you will then
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accrue interest at the new rate set in
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november for the next six months
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again that's not necessarily when you'll
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receive that rate it will be six months
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after you bought the bond
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so if you bought the i-bond in october
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you would accrue interest at the current
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rate for the next six months
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and only after that with the most recent
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update to the rate in november take
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effect
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this might seem a little confusing so
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definitely rewind and review this to
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make sure you understand
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also keep in mind that the interest is
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compounded semi-annually so every six
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months from the bonds issue date the
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interest the bond earned in the six
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previous months is added to the bond's
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principal value creating a new principal
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value
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interest at the updated rate is then
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earned on the new principal
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the interest and principal are paid to
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you only when you cash in the bond
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so let's take a step back and think
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about this composite rate of 9.62
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percent
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if you currently have an i-bond or if
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you buy one at any time between may and
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the end of october 2022
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you are guaranteed to receive monthly
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interest of 9.62 percent for six months
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let's say that again nine point six two
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percent on a us bond a bond that is
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backed by the full faith and credit of
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the united states government that up to
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this period in time the u.s government
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has never defaulted on its debt which
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makes it about as safe as you can get
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now consider what your bank savings
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account rate is what cds are paying what
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money markets are paying
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nowhere near 9.62 right
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now in a good year stocks can definitely
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beat that rate but the question we have
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to ask ourselves is do we think the
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market will do that this year
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it's often said and very true that it's
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really hard to predict how the stock
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market will perform in the future
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particularly during shorter time
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horizons such as 12 months
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it could go up or it could go down
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having said that with the headwinds of
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more interest rate hikes coming and
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inflationary pressures on companies
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expenses than the overall economy in
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general
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there's a lot of sediment that the
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market might be flat at best in the
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upcoming year
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in this situation you have to ask
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yourself
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do you take the chance on the
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uncertainty of the market versus a
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guaranteed nine point six two percent
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interest over six months
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the guaranteed nine point six two
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percent sounds very tempting in this
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current economic climate doesn't it
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well before you move forward in buying
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an eye bond which i'll tell you how to
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do in a minute i do want you to be aware
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of a couple of reasons that may make you
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want to think twice before jumping in
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probably the biggest reason to consider
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not investing in an i-bond is that once
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you buy one
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you can't cash it in for at least 12
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months
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there's just no way around it so if you
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were to need that money you won't be
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able to access it for a full year
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because of this an ibond is not where
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you would want to put your emergency
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funds or money you may need within the
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next year
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now after a year passes you can sell it
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anytime afterwards but something else to
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keep in mind is if you cash it in before
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holding it for less than five years you
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would have to forfeit the last three
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months of interest so that's an
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important consideration as well
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now after five years there is no penalty
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where you have to forfeit any interest
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when you cash the bond in
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to me losing that last three months of
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interest by cashing in after holding it
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under five years is a lesser problem
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particularly if you're getting a much
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better rate than you could elsewhere
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over the course of a year
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but again the bigger issue is if you
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need that money within the first 12
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months of buying the i-bond you just
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can't get to it
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the other big consideration is if you
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buy the i-bond now from may through
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october you're only guaranteed to get
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that nine point six two percent interest
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rate for six months
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but as i just said you have to hold the
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i bond for at least a year
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once again that rate sounds good right
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well that's only because inflation is
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high right now but there's no guarantee
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that the interest rate will stay that
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high when the rate is reset in november
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in fact as the fed continues to hike the
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federal reserve rate throughout the
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summer it's likely to start slowing the
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rate of inflation which would mean that
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the variable inflation rate component of
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the i-bond will be lower than it is now
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leading to lower interest that will be
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accrued
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and to that point many analysts and
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economists believe that this might be
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the peak of inflation
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so if that's the case and the inflation
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rate is reset lower in november your
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money is no longer making 9.62 percent
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now in a completely hypothetical worst
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case scenario let's say that the
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inflation rate drops to zero percent or
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even if it goes negative where deflation
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occurs
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even if that were to happen you still
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would have a 4.81 return for the 12
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months which would still be better than
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any interest-bearing bank savings
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account
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of course the main issue being that you
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don't have access to move your money
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into something else within those 12
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months
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another thing to consider is that in a
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calendar year you are limited to
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investing up to ten thousand dollars in
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most cases i'll tell you what i mean by
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that in a minute
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now if you're married your spouse can
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also invest up to ten thousand dollars
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so a couple could invest up to twenty
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thousand dollars ten thousand per person
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now ten thousand dollars is nothing to
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sneeze at but if you're someone that has
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a fairly substantial amount of savings
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this just means that i bonds won't be
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able to fully hedge your investing
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capital against inflation
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so let's say you have two hundred
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thousand dollars in brokerage or bank
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accounts
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you would only be able to park ten
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thousand of that or five percent of your
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portfolio in i-bonds so you're just
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limited how much of your capital you can
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hedge against inflation using i-bonds
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that doesn't mean you shouldn't consider
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it but just to realize it's not the
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answer for fully protecting your money
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now as i alluded to a second ago there
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is one other way to buy additional eye
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bonds over that 10 dollar limit
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but that can only occur if you have an
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income tax refund where you can request
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up to five thousand dollars in paper i
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bonds
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otherwise you're limited up to ten
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thousand dollars in eye bonds and those
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can only be purchased electronically
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and unlike other types of investments
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such as tips where you can buy them from
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banks and brokers on the secondary
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market you can only buy series i-bonds
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directly from the us treasury at the
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treasury direct website
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which is at www treasury
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because the bonds are electronic you
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have to open up an account at treasury
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direct where your bonds will be held
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you'll also have to link a bank account
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where you can transfer your funds back
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and forth
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setting up the account isn't difficult
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but it is another account that you have
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to keep track of and i know a lot of
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people like to keep all of their savings
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and investments in one place
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as far as how much you can buy them for
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you can buy them starting at a minimum
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of 25
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up to the annual limit of ten thousand
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dollars
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so let's say you decided to buy an eye
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bond what does that mean for taxes
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well first of all the income earned is
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taxable in your federal return however
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it is not taxable for your state and
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local tax returns
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although you can choose to report your
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interest income every year the majority
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of people defer reporting the interest
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until the year they cash in the bond
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i think this is a good time to remind
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you that while my videos are meant to be
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informative they should not be seen as a
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recommendation for you to take any
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action based on the information or the
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personal opinions i share
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you should always do your own research
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or consult with your own financial
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advisor while making any investment
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decision
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and considering taxes is a big part of
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that and how it relates to your
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individual situation
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so i think that about covers the basics
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on series i bonds what do you think
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are they something that you're going to
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consider
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or do you have another strategy to hedge
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against inflation let us know in the
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comments we're always looking to learn
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from each other here
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i hope you enjoyed the video and if you
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did please press that like button and
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share with your friends and on any of
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your social media sites and forums
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you're on to help spread the information
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and if you're new to the channel or just
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an occasional visitor we'd love to have
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you join the community you just gotta
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press that little red subscribe button
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we'd love to have you on board
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until next time thank you for watching
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and have a great day
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[Music]
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