I Bond Yield At 5.34% Is Still A Good Deal But Some Thinking Is In Order

This morning, at 7:30 (Wednesday, April 12), we got the March numbers for inflation. This completes the six-month period which will determine the variable rate for I Bonds which will reset on May 1. On that date, TreasuryDirect will announce the fixed rate going forward for all buyers from May 1 to Oct. 31. That means you have about two weeks to think about the action you wish to take, if any. Those two-week periods occur twice a year, in late April and late October, when the last of six months of CPI-U numbers is in. During that period an I Bond investor knows exactly what the one-year variable return will be. That provides the edge which is one of the many factors that make I Bonds different from most investments.

The great advantage with I Bonds is the fact that you can buy them with your first year's return known in detail. It's as if you were handed a crystal ball which told you where the stock market would be in a year and gave you an opportunity to think about it for two weeks twice a year. With the Wednesday morning CPI report the clock is ticking on the April window. As soon as you finish this article and understand I Bonds clearly, you should sit back and start thinking about what action you should take.

You should decide, ideally, in time to act a few days before May 1. Last year with the tremendous and unprecedented demand for I Bonds, TreasuryDirect was overwhelmed with answering questions and processing purchase orders. To the best of my knowledge everyone who placed an order eventually succeeded in buying their I Bond but this didn't help those who needed help and gave up when they couldn't get through on the phone. I did my best to answer commenter questions quickly and will do so again. You may rest assured on one question. The Treasury can't run out of I Bonds. There should be less interest in buying this year as I Bonds have more competition in other fixed income assets but if interest continues to be high TreasuryDirect may be short of people to answer phones.

What Are I Bonds And How Do They Work?

I Bonds are an inflation-adjusted version of U.S. Savings Bonds. They're as safe as all U.S. Treasury securities, which are the standard of safety against which all other investments are measured. To buy them you first establish an account on the TreasuryDirect site. If you have my poor level of competence in navigating websites get reinforcement from a reasonably bright family member between the ages of eight and 30. That's what I do. You can tip the family member by providing a small sum for them to buy an I Bond for themselves. You can also take the opportunity to give a short lecture on frugality and thrift.

There are two components to I Bonds, the inflation-adjustment component and the fixed, or real rate, real meaning the rate after inflation. The variable rate is updated twice a year on May 1 and Nov. 1. The fixed rate remains for up to 30 years when the I Bond matures or until the bond is redeemed. The current fixed rate is .40% and one of the current unknowns is whether the rate will be increased and on May 1. The rate was raised from zero to .4 last Nov. 1. Until that reset the fixed rate had been zero for much of the time in recent years.

I Bonds are held electronically and cannot be removed from your account until redeemed. I Bonds were created in 1998 as the savings bond variant of Treasury TIPS available to small investors. They were first issued through banks, and the owner received paper copies, but in 2012 paper bonds were phased out except for those received as part of tax refunds. My first purchase, by the way, was in 2000, and I have bought them every year since and never cashed a bond in.

The annual limit per person is $10,000 per Social Security Number and another $5,000 as part of you tax refund. There's also a trick using the Gift Box, created so that you can buy I Bonds as a gift to a person of your choice. A gift can be used if you have a friend or family member with whom you feel comfortable swapping gifts. The details are a little complicated, but I did it successfully with a little help from a youngster in the family. We owe a debt of gratitude to the person who allowed this loophole to materialize until it was too late to change. May that person live long in good health.

I Bonds come with quite a few other advantages. Like all Treasuries they're not taxable by state and local governments. Federal taxes may be paid or deferred until maturity but you must decide in the beginning and stay with that decision. This ability to delay taxation gives I Bonds an edge compared to TIPS for which both the inflation adjustment and the fixed rate are subject to Federal taxes on a year-by-year basis. If I Bonds are likely to end up in your estate you might leave them to an heir whose tax rate is likely to be low.

A few other quirks add to the advantages of I Bonds. They compound automatically on May 1 and Nov. 1. In the event of a six-month period with negative inflation, the accrued inflation adjustment freezes and then resumes increasing when inflation returns. The temporary decline in fixed rate, however, cannot go below zero. This provides de-facto defense against deflation, which interestingly provides an increase in real value.

There are a few rules that come with I Bonds. You can't redeem them for a year. Some buyers have bought them in the past two years as a short-term investment which has a safe high yield. There's nothing wrong with that, but getting out not only takes that year, but there's a three-month sacrifice of income if exiting in the first five years. Unless in dire need of cash, even short-term investors should at least wait to exit after a quarter of relatively low returns.

The one-year and five-year rules often confuse first time investors because quarterly interest which cannot be immediately accessed because of the rule is not included in calculations

A full month of interest is paid at for a bond held at any point in the month so it is advantageous to buy in the final days of a month or redeem on the first day. That can make a 12-month period produce interest for almost 14 months. In sum, I Bonds do quite a few favors for the small saver/investor.

This section is the short version of details on the working of I Bonds. For readers new to the subject or who wish to refresh their detailed knowledge I suggest this most recent article on the subject and this article which was my first detailed treatment of the subject. It has the most detail on I Bonds and includes a version of the table in the next section providing an interesting picture for several years going into the burst of high inflation.

A Closer Look At The Data

The table below lays out what we know and how it is derived.

Six Month Percentage Change: 1.69% (3.38% annualized)

Six Month Percentage Change: 3.24% (6.48% annualized)

Six Month Percentage Change: 4.81% (9.62% annualized)

Six Month Percentage Change: 3.56% (7.12% annualized)

The table above contains an astonishing amount of information. The number that will interest most readers is the variable rates on I Bond bought before May 1. (As always, I suggest that those who wish to buy before May 1 to do so with a few days to spare.) The variable rate before May 1 will be calculated by combining the last two Six-Month Percentage Changes, 3.24% and 1.69 %, which sums to 4.93%, then adding in the .4% fixed rate. That produces the one year rate which with rounding done by an algorithm come to 5.34%.

By starting at the bottom of the table you can see the path inflation took from its original jump to 4.2% M/M to a peak of 9.1% M/M in June of 2022. From that point it receded about twice as fast as it had increased to the current 5.0%. Note that this is the basic CPI number. The core number excluding food and energy came in at 5.6%, a number you may see featured in some articles. It's worth noticing that the current 5% provides a certain symmetry with the May 2022 date when the CPI first reached 5% on the way up.

As I wrote in my last article, my favored interval for understanding what's happening right now is month over month, as close as data get to instantaneous rate of change. That number has been low and falling for the entire six month period through March and also for the last three months of the period from April through December of 2022. What makes that particularly interesting is that the three months from April through the peak month of June 2022 will fall off the one-year series this coming June. Much of the high year over year rate reflects numbers that reflect a high and peaking period in 2022. When those numbers fall off the one-year data, the high headline number for year over year inflation will drop like a rock. This has been my working model for many months, and so far it has been accurate.

A note on inflation. Inflation is a rate of change. It does not mean quite the same thing as high prices. It's likely that prices will not go back to what they were before 2021. If they simply stay where they are now, the inflation rate will be zero. This probably won't happen, but it's likely inflation will return to a more normal rate of change. Fed decisions will have impact on that but in my opinion less than many analysts think.

What Action Should You Take?

Going into the CPI report my intention was to stay with my long-term policy of buying the $10K maximum as I do every year. My expectation was that it made more sense to buy in April than to wait until May 1 or after. Close examination of the numbers reported today and the table above reinforced my intentions. The leading reason is that it's the last shot of the 3.24% six-month rate going back to April 2022. The rate for the six months just passed is barely over half that at 1.69%. There's a significant likelihood that the latter number will be the beginning of an era with lower variable rates.

Bear in mind that the 1.69% number for the past six months amounts to an annualized inflation rates of 3.38%. That's not much above the 100-year inflation average. In a healthy growing economy few would complain of that right and the Fed might ultimately settle for 3% although currently jawboning for 2%. Don't forget that an inflation rate around 2% took a powerful effort by the Fed to suppress rates. This made life difficult for income investors.

As for the fixed rate there's a possibility that the Treasury may raise it from .40% to .60% to reflect higher rates in ordinary Treasuries and other fixed income instruments. There's an outside chance the rate could be even higher but the decline of inflation over the past nine months and the more recent decline in Treasury rates make this unlikely. One reason to wait and see is that if there is a generous rise in I Bond real rates you can always use your next year's $10K to buy in January.

The long-term future of I Bond rates is more interesting. It was always my view that sharply rising rates which began to unfold in early 2021 were likely to be temporary. My view was that they were like the brief couple of years of high inflation following both world wars. For the winners of WWI and WWII the wars left soldiers and the war time work force had cash on their hands while wartime production had not yet switched to civilian goods. This produced sharp inflation for a couple of years before demand and supply got back into balance. Both bouts of inflation were followed by a couple of years in which deflation brought prices back down although not back to where they started.

The current inflation was like war inflation due to cooped up demand. Whatever it was, the recent burst of inflation was nothing like the 1970s in which the idea of rising prices was deeply implanted in the minds of both consumers and businesses. The Federal Reserve view of temporary inflation was essentially right but off a bit in its timing.

Unless there's a fresh and unforseen economic or financial event - inflation driven by expansionist fiscal and monetary policy to fight should soon pass through the economy leaving more normal spending. Both the Fed and the fiscal authorities went overboard to be sure the shutdown of the economy didn't get out of hand. Sharply rising rates have corrected this and possibly gone overboard.

I Bonds are likely to become less attractive starting next year and continuing for quite a while. The next few years should resemble the decade from 2011 through 2020 in which inflation was 1.9%. That still resulted in a 21% reduction of the value of the dollar. I continued to buy the max in I Bonds throughout that period because rates in general were low and my I Bond portfolio served as an insurance policy in case inflation arrived in force. Other things being equal I would probably continue with my policy every year but the Gift Box changed the picture.

How To Think When Using The Gift Box

I Bonds occupy an unusual place between past and future. You can start your I Bond position with an assured return going back a year into the past. You may then hold an I Bond for up to a total of 30 years into the future. The Gift Box creates the possibility of concentrating more in a current year when you already know that the first year's return will be great. Then in a separate action in the future you have the Gift Box I bonds "delivered" into your account in years when I Bond returns are likely to be low. I arranged for two $10K swaps into I Bonds offering over 8% in April of 2022. I'm now very interested in the way inflation unfolds in 2024 and 2025 to see if they are good years to have I Bonds "Delivered" in lieu of my annual $10Y purchase. Here's what I wrote on Oct. 13, 2022:

Reader comments to previous I Bond articles prompted me to study up on the Gift Box in April of 2022 and after studying up quite a bit I worked a reciprocal Gift Box exchange in my family and put together an article on the Gift Box here. The only real complaint about I Bonds is that you can't buy enough of them. The Gift Box and a few other workarounds - a Revocable Living Trust or your personal business - may enable you to do more. While only the Gift Box option is timely for present action, I suggest that those who are interested in the other options Google The Finance Buff/I Bonds. He does an excellent job in laying out the details of the other options for doubling and also provides an excellent guide to the workings of the TreasuryDirect site.

The premise for doubling up with Gift Box I Bonds is simple:

1. Buy when the known inflation component is exceptionally high. That includes any time between the moment you read this and November 1. I actually suggest a few days earlier to be sure you don't get pushed into November by a glitch or slow processing.
2. Have the I Bond "Delivered" into your account in a future year when the known return prospects are lower.
3. You may do this as a Gift to a friend or family member, or you can pair up to do this reciprocally. It's a tactic often used by husband and wife or other family members with one another.
4. You may repeat as many times as you want but be aware that you will need to forego an annual purchase for each $10K you wish to eventually have "delivered."

The delivery part is the reason for devoting a little thought to the probabilities concerning inflation over the next few years. If you are old like me you have to take into account the potentially limited amount of time to carry out the strategy or educate others as to how they should proceed if you are not around. This brief article was written as a detailed Gift Bond follow-up to an earlier I Bonds article.

The Lady With The Dog

No, not the famous Chekhov story. My wife noticed that many commercials include a dog and suggested that I use the above picture of a nice lady and a nice dog. I save it for the most important and helpful articles. The story is that she has figured out I Bonds in full detail and has been buying her max for three years including Gift Box purchases swapped with three of her children. She is smiling with satisfaction and her dog clearly appreciates her sagacity and daydreams of doggy treats.