The Inflation Hedge You’ve Never Heard Of
If rising prices have you worried, one way of insulating your nest egg comes straight from the government: Series I savings bonds. Right now they’re paying 7.12%.
Inflation readings reached four-decade highs of 7.5%, the Bureau of Labor Statistics reported on Feb. 10, and the potential of further erosion of real purchasing power has everyday consumers and investors worried. Over 70% of participants in a recent USA Today/Suffolk University study indicated that inflation is their main economic concern, versus just 24% who cited jobs. Many investors are asking themselves how they might insulate their portfolios.
Gold, commodities, Treasury inflation-protected securities (TIPS) or maybe bitcoin come to mind when thinking of inflation hedges. While all tend to work to some extent, each has its own quirks, and none cleanly moves in lockstep with inflation.
Enter I bonds
Series I savings bonds, or I bonds, are issued and backed by the full faith and credit of the U.S. government and pay an interest rate directly tied to inflation. In short, as prices rise, so does the interest earned. Series I bonds are different from other bonds, so it’s important to understand how they work when deciding whether they are a good fit for your personal savings or portfolios. It’s also worth noting that I bonds are subject to interest rate and market risks.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Distinctive rate structure
One of the things that sets I bonds apart from other investments is their rate structure. There are two components that help determine the Series I bond rates: the fixed rate and the inflation rate. The fixed rate is set at issuance and persists for the life of the bond. The second component resets semi-annually based on the non-seasonally adjusted Consumer Price Index for All Urban Consumers (CPI-U) for all items, including food and energy. The inflation rate and the fixed rate, adjusted for inflation, are combined to get the overall interest rate.
The bonds accrue interest monthly until they reach their 30-year maturity or you cash them, whichever comes first. For the current period running from November 2021 to April 2022, the fixed rate is 0.00% and semiannual inflation rate is 3.56%, amounting to a composite rate of 7.12%. Rates will reset again in May, and with the way inflation has been going investors can expect yields on I bonds to likely stay elevated.
They’re also tax efficient. You can defer tax reporting on interest until the bonds are redeemed, expire or some other taxable disposition. Interest is subject to federal income tax, but not state or local taxes. Check with a tax professional to see what makes sense for your situation.
Any gotchas?
Kind of. An investor must hold an I bond for at least 12 months before redeeming it. After the first year an investor can redeem their bond, but redemption before five years have elapsed will result in a penalty worth the interest of the previous three months. For example, if you redeem a bond after 18 months, you will receive the principal plus the first 15 months of interest.
Purchases are limited to $10,000 per person per year and only available through TreasuryDirect.gov. You can buy up to $5,000 additional bonds using your federal income tax return for a total annual purchase amount of $15,000.
Deployment within a financial plan
Investors with larger portfolios will quickly run into the annual purchase limit if they try to use I bonds to hedge inflation entirely. Such investors may want to consider using I bonds with other inflation-hedging strategies, such as TIPS or a broad-based commodities basket. An investor may also consider swapping out low-yield cash savings for I bonds, particularly those past their 12-month lock up period, as part of their emergency fund.
Amid volatile markets and escalating inflation, I bonds can help investors achieve a higher yield with the safety of a bond backed by the U.S. government. I bonds can hedge your portfolio against inflation, but it’s important to remember the money invested is tied up for the first year. When in doubt, check in with a financial adviser or professional who can help guide you.
Series I bonds can be a good fit for some investors, and are especially worth exploring in an inflationary environment.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Adam Grealish serves as Head of Investments at Altruist, a fintech company on a mission to make great independent financial advice more affordable and accessible. With a career rooted in financial innovation, Adam most recently led Betterment's strategic asset allocation, fund selection, automated portfolio management, and tax strategies. In addition, he served as a vice president at Goldman Sachs, overseeing the structured corporate credit and macro credit trading strategies.
-
Setting Objective Criteria for Employee Bonuses Aligned With Company Goals
When employees win, the company wins.
By Stephen Nalley Published
-
A Modern Guide to Money Etiquette: Gifts, Tips, Splitting Bills and More
What is modern money etiquette? The customs for splitting a restaurant check, purchasing a wedding gift, tipping and more have evolved. These guidelines can help.
By Emma Patch Published
-
Potential Ripple Effects of Taxing Unrealized Capital Gains
The proposed tax on unrealized gains would be limited to those with a net worth above $100 million, but some see a broad impact on markets and businesses.
By Brian Skrobonja, Chartered Financial Consultant (ChFC®) Published
-
Succession Musts: Thoughtful Planning and Frank Discussions
When it comes to passing on the family business, you don't want anyone to be surprised about who will control or inherit the business after the owner's death.
By David Handler, J.D. Published
-
Here's How to Find Your Way Out of the Inherited IRA Maze
To navigate complex rules on inherited IRAs and RMDs, start by breaking down key terms and common scenarios. A clearer picture of your next steps will emerge.
By Evan T. Beach, CFP®, AWMA® Published
-
Should You Move Your 401(k) to an IRA Once You Hit 59½?
Some 401(k)s allow for in-service withdrawals at age 59½, opening up greater investment options. Here are three reasons for taking the plunge.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
When It Comes to Insurance, How Much Risk Can You Take?
Either you or an insurance company takes on the risk of protecting your belongings from loss or damage. Can you afford to self-insure?
By Karl Susman, CPCU, LUTCF, CIC, CSFP, CFS, CPIA, AAI-M, PLCS Published
-
Five Ways to Minimize a Higher Capital Gains Tax Rate
With Harris’ proposal to raise the capital gains tax rate (which would require congressional approval), investors might want to consider tax-lowering options.
By Michael Aloi, CFP® Published
-
Collar Investing Strategy Can Help Protect Your Nest Egg
Here are some key considerations for using the collar strategy of put options and covered calls to safeguard your wealth in retirement.
By Matt Amberson Published
-
Understand Your ESOP Benefit: The Diversification Option
You can sell your shares back to the company during your employment years, called diversification in ESOP terms. What are the pros and cons?
By Peter Newman, CFA Published