A Government Bond with Guaranteed Interest. Do I Bonds Belong in Your Portfolio?

Bonds? Why would anyone in their right mind want to invest in bonds? Bonds are getting hammered! Bond markets are down approximately 9.5% so far this year (Vanguard Total Bond Market Index ETF). With continuing high inflation and rising interest rates, bond performance will likely get worse.

But there is one type of bond an investor may wish to consider adding to their portfolio. They are Series I Bonds offered only by the US Treasury. I Bonds have not received much attention because interest rates offered on them have been too low to attract investors - until now.

What makes I Bonds so attractive you ask? Simply an I Bond’s interest rate is tied to the inflation rate, so that if the inflation rate goes up (as we’re experiencing now), the interest paid on an I Bond goes up as well. Plus, being a US government issue, I Bonds offer safety of principal.

An I Bond has 2 interest rate components. The first is a fixed interest rate. The Department of Treasury announces the fixed rate twice per year (every May and November). It is an annual rate and once you purchase the I Bond the fixed rate never changes. Currently, Treasury is offering I Bonds with a fixed rate of 0.0%. (The fixed interest rate on an I Bond can never by less than zero.) The second component is a variable interest rate that is tied to the Consumer Price Index for all Urban Consumers (CPI-U). So, if the index rises, so too will the variable interest rate paid on your bond. The I Bond variable rate resets every 6 months, in May and November, according to the then consumer price index. I Bonds issued from May through October 2022 are offered with a six month inflation interest rate of 4.81% (9.62% annualized!)

When you purchase an I Bond, the inflation interest rate will be locked in for the first 6 months of ownership. Thereafter, the interest rate paid on your I Bond will reset every 6 months until the bond is redeemed to reflect then-current inflation rates. Every six months from the bond's issue date, interest the bond earned in the previous six months will be added to the bond's principal value, creating a new principal value. Interest is then earned on the new principal value.

An investor must hold an I Bond for at least 12 months. Thereafter, one may redeem the bond; however, if the bond is redeemed before it is five years old, the investor loses the last three months of interest. An I Bond earns interest for a maximum of 30 years, if it isn’t redeemed before the maturity date.

Any individual with a Social Security number may purchase an I Bond as long as they are either: a) a US citizen, b) a US resident, or c) a civilian employee of the US government regardless of place of residence. Individuals may purchase up to $10,000 of I Bonds per year ($20,000 for a married couple). An investor has the ability to purchase an additional $5,000 in a given year with their federal income tax refund.

I Bond interest is subject to federal, but not state or local income tax. You may report the interest earned on your I Bond every year, or you may elect to report the interest income when the bond is redeemed or when it fully matures. (Many individuals find it advantageous to wait until redemption to report the interest because it gives them some control over the total amount of reportable income in any given year.)

Will I Bonds work for you? For the right investor, an I Bond may be a good fit in a portfolio to soften some of the impact of inflation. However, the low investment limits curtail the advantageousness of the inflation fighting opportunity I Bonds offer.

You can set up your online account through the US Treasury website, TreasuryDirect.gov, and thereafter purchase, trade, or redeem I Bonds or any other Treasury security.