The stock market’s subpar performance has prompted many investors to seek alternative investments and diversify their portfolios. Lower stock prices usually result in rising bonds, hence their appeal.
But owning bonds provides investors with benefits other than hedging their investment against falling stock prices. I bonds can be an ideal investment to combat inflation and earn interest. Benzinga explains what I bonds are, their features, where investors can buy them and the benefits of owning them.
What Are I Bonds?
A Series I bond is a U.S. savings bond that earns interest and helps protect you from inflation. I bonds are a low-risk, high-yielding investment because they provide a fixed interest rate and a variable inflation rate. The variable interest rate is adjusted semiannually to keep up with rising consumer prices. That protects the value of your cash during inflation.
As an I bond investor, you get the best of both worlds by receiving returns and protection from inflation. You earn monthly interest, which is compounded semiannually. That results in the government applying the interest rate to the new principal value every six months. The government calculates the new principal as the total of the previous principal and the interest earned in the last six months.
Fixed Interest and Inflation Rate
The U.S. Secretary of Treasury determines the fixed interest rate, which applies to I bonds issued in the next six months. The Consumer Price Index (CPI) serves as the basis for determining the rate of I bonds, which is announced in May and November. The growth of the principal’s value and the interest you earn increase your I bond value in two ways.
I bonds mature after 30 years. The original maturity period is 20 years, then a 10-year extended maturity follows. The Treasury allows you to cash in the bonds after the first year of purchase. You’re penalized the last three months of interest earned if you cash in the bonds within the first five years of ownership. No interest penalty applies for redemption after the first five years.
Besides being an inflation hedge, I bonds are considered very low-risk investments because the U.S. government backs them, and their redemption value doesn’t decrease. You cannot lose your principal, which is the amount of money you used to buy the I bond. The downside of opting for a low-risk investment such as an I bond is lower returns than the ones potentially earned from high-risk assets.
I bonds are exempt from local and state taxes. You can choose to report the annual earnings each year or only when you receive the money for the bond.
One way of not paying tax on the earnings is to use the money to fund qualified higher education. If you received I bonds as a gift, you have to pay the taxes. It’s the owner, not the purchaser, who is responsible for the taxes.
The Treasury lists all interest rates issued for bonds either as a table that separates the fixed rate, inflation rate and combined rates or a matrix showing the inflation rate, fixed rate and combined rates together.
It calculates the I bond interest rate using the composite rate, which consists of the fixed rate determined at the purchase price and lasts throughout the duration of the bond ownership, and the inflation rate, which is set every May and November.
The formula for the composite rate:
= Fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)
Where to Buy I Bonds
You can buy I bonds via the U.S Treasury Direct’s website. They are not available from your broker.
You’re allowed to buy up to $10,000 worth of I bonds annually. TreasuryDirect allows investors to buy paper I bonds with their tax refunds up to $5,000 in $50 increments. That increases your allowable annual I bond purchase to $15,000.
You can buy electronic or paper I bonds. The minimum amount for electronic I bonds is $25, and you can buy pennies above that amount. Paper I bonds are sold in denominations of $50, $100, $200, $500 or $1,000.
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Why Buy I Bonds?
A well-diversified portfolio has proven to overcome almost any market condition. Adding I bonds to your portfolio may combat economic hardships and offer several other benefits a simple savings account can not offer.
Stocks are a popular investment option, but their value usually drops during economic turmoil. To protect your portfolio from decreased stock prices, you can use I bonds as a hedge. I bond prices tend to increase when stock prices drop.
Owning I bonds exempts you from paying local and state taxes on them. If you choose to invest the earnings made from I bonds into higher education, you could also be exempt from federal taxes.
The U.S. government backs I bonds, meaning you’re guaranteed of receiving the full payment of the invested principal at maturity. Also, the combination of earning from the fixed and inflation rate means your cash is protected from inflation and the bond’s value grows from two sources.
I Bonds provide numerous benefits, making them an appealing investment option. These U.S. savings bonds offer protection against inflation and earn interest. With a fixed interest rate and a variable inflation rate, investors receive stable returns while safeguarding their cash value. The U.S. government backs I Bonds, ensuring a low-risk investment with a guaranteed principal. They also offer tax advantages, exempting investors from local and state income taxes.
Adding I Bonds to a well-diversified portfolio acts as a hedge against economic downturns, and their unique combination of fixed and inflation rates provides growth opportunities as opposed to a normal savings account. Consider I Bonds to enjoy the benefits they offer.
Frequently Asked Questions
What is the purpose of an I Bond?
An I bond is a government bond established to protect the investor’s value of money from inflation. The CPI is used by the U.S. Secretary of Treasury to determine the inflation rate applied to I bonds. The I in I bonds stands for inflation.
Are I Bonds a good investment?
Investment risks and goals vary for each individual. Investors should compare the features and benefits of a Series I bond to their investment goals. If the two align, investors may consider I bonds to be a good investment.
Should you invest in I bonds?
Investing in I bonds depends on your financial goals and risk tolerance. They can be a good option for low-risk, inflation-protected investments, but it’s important to consider factors such as interest rates and other options available. Consulting with a financial adviser can help determine if I bonds align with your strategy.
About Goran Radanovic
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