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I Bonds Are A Terrible Investment

Inflation in the US economy is real, and likely to get worse.  Those wishing to better understand what inflation is and how it affects retirees can reference my May 11 blog post.

With inflation looming, investors are understandably concerned and seeking ways to protect their purchasing power from the inflation threat.  A June 6 article on CNBC entitled "Here’s an option to protect your portfolio from inflation" suggested I Bonds as a solution for investors.  I couldn't disagee more.

What Is an I Bond?

I Bonds, formally known as Series I Savings Bonds, are issued by the US Treasury.  According to TreasuryDirect, "Series I savings bonds are a low-risk savings product. During their lifetime they earn interest and are protected from inflation."

Other features of I Bonds:

  • I bonds have an annual interest rate derived from a fixed rate and a semiannual inflation rate.
  • Interest, if any, is added to the bond monthly and is paid when you cash the bond.
  • I bonds are sold at face value; i.e., you pay $50 for a $50 bond.  Bonds can be easily purchased by the public at TreasuryDirect.
  • Minimum term of ownership: 1 year
  • Interest-earning period: 30 years or until you cash them, whichever comes first
  • Early redemption penalties:
    • Before 5 years, forfeit interest from the previous 3 months
    • After 5 years, no penalty

 I Bonds issued between May and October 2021 have a current rate of 3.54% as long as they are held at least 5 years.

Wow!  I Bonds Sound Great!

To the untrained eye, I Bonds seem appealing:

  • Guaranteed principal (i.e. you can't lose money)
  • Backed by full faith and credit of the United States
  • Return tied to inflation via semi-annual adjustments

All of the above are features that would be useful as a savings vehicle (i.e. as an alternative to cash, bank deposits, CDs, etc.).  But they are not useful ways to "protect your portfolio from inflation" as suggested by CNBC.

Poor Tool For Investment Portfolios

I Bonds have a number of drawbacks as part of an investment portfolio:

  1. Lack of liquidity.  I Bonds must be held at least one year, and at least five years to avoid forfeiting interest.  We find that our clients like having 100% liquidity.
  2. No income.  When people think of bonds, they assume their bond pays them a steady stream of income until maturity.  Not these bonds.  According to TreasuryDirect "Interest, if any, is added to the bond monthly and is paid when you cash the bond."  Why invest in a bond that pays no income?
  3. Purchase limits.  Investors can only purchase $10,000 per year of I Bonds.  How on earth is a retiree supposed to protect their portfolio from inflation if they can only hedge $10,000 per year?  This makes I Bonds useless for the vast majority of retirees.
  4. Potential loss of purchasing power.  Current I Bonds are issuing at 3.54%.  Yet actual inflation in April was 4.16% annualized suggesting that buyers are already losing to inflation as soon as they purchase the I Bonds.  Will the semi-annual adjustments be able to keep up with inflation over the next 5 years?

Net, I Bonds are illiquid 5 year bonds that generate no cash flow and may or may not even keep pace with inflation.  And even if that somehow sounds appealing to you, you're still limited to only buying $10,000 of them this year.  Gee, what a great concept!

What Can Investors Do Instead?

Buy stocks in well-run companies that pay dividends.  Over rolling 5-year periods, large company stocks are positive 87% of the time, with a long term return of 10%.  Many stocks also pay dividends, with the long-term dividend yield on the S&P 500 hovering around 2%.  Stocks are liquid and have no purchase limits.  That sounds like a lot better retirement investment than I Bonds.

When we build retiree portfolios at Oxford, we seek a balance between Stability and Growth following the principles outlined in our proprietary Power of 5 Investing system. Our goal is to help clients achieve inflation-beating growth in their wealth, while managing through market downturns. Our system has been battle tested in 25+ years of market ups and downs and is ready to tackle inflation. If you or someone you know would like to learn more, contact us today for a free get acquainted meeting.