After hibernating for decades, inflation has awoken and consumers are taking notice wherever they regularly spend money.
Inflation picked up in the second half of 2021 and has hovered around 6 percent, recalling year-over-year price increases last seen in the 1980s. It’s a rather sharp departure for consumers who, for over a decade, rarely saw prices rise more than 2 percent from one year to the next.
To earn inflation-beating returns on savings, you typically need to take more economic risk – it’s why money in a savings account won’t generate stock-like returns. That presents a conundrum for savers who are looking to fund intermediate-term goals, such as a wedding, college education or new home. In a nutshell, money that won’t be spent for several years but still well before retirement.
Here’s the rub: An intermediate-term goal is far enough away that inflation is worth accounting for to maintain purchasing power, but you’ll need it soon enough that risking it in markets isn’t ideal either. One option to consider as part of a broad financial plan are Series I savings bonds (I bonds) from the United States government. They are an inflation-protected, lower-risk option to help preserve the purchasing power of a portion of your savings when inflation is rising.
What are Series I Savings Bonds?
When you buy a Treasury bond, you’re essentially lending the United States government money. In return for borrowing money, the U.S. government will pay you coupon interest payments over the life of the bond. If a bond is held to its full maturity, the principal value of the bond is paid back. Treasury bonds are fully backed by the U.S. government, so they are considered low-risk investments.
Series I bonds are a type of Treasury bond, but rather than a single coupon rate you are paid a composite rate that is determined by two factors: a fixed rate that’s set by Treasury and a semiannual inflation rate. In other words, throughout the bond’s life the interest you earn is adjusted twice a year to account for inflation.
Today, I bonds purchased through April 2022 sport annualized yields of 7.12 percent, the highest rate since they were introduced in 1998 and more than double the yield on a 30-year Treasury bond. They may have a place in some financial plans, but there are a few things to know.
Here’s what to know about I bonds
Here are the key things to know about I bonds:
Your rate of return: The interest on I bonds is a combination of a fixed rate and the inflation rate, which is reset every six months. Currently, the “fixed rate” on an I bond is 0 percent, but accounting for inflation the composite rate is 7.12 percent. The composite rate is what you’ll earn for the first six months you own the bond. The inflation is compounded every six months from the bond’s issue date and accrues until it matures in 30 years or when you sell it.
A word on selling: You must hold I bonds for one year after purchase, and if you sell your bonds within 5 years, you’ll forfeit interest earned in the prior three months. Therefore, be sure you won’t need to access money invested in I bonds for at least a year.
What if inflation changes? As inflation rises or falls over six months the composite rate will rise and fall accordingly. However, your composite rate of return will never be negative even in periods of declining prices (deflation).
Where can I find out more about I bonds? I bonds are sold directly by the US government. For more information visit TreasuryDirect.gov.
All part of a plan
I bonds are an option to fill a specific need for savers, but like any financial product they may not be appropriate for everyone. If inflation and finances are on your mind, it may be helpful to sit down with a financial planner who can help you design a strategy that accounts for rising prices today and down the road in retirement.
This article is for informational and educational purposes only and should not be interpreted as financial or investment advice. Northwestern Mutual Financial Representatives cannot sell or recommend the purchase of I bonds.
All investments carry some level of risk including the potential loss of all money invested. You should carefully consider risks with fixed income securities such as bonds, these include: Interest rate, Duration, Credit, Default, Liquidity and Inflation.