How Series I Savings Bonds Work

A reader asks:

My husband and I are both in our early-mid 30s with 30+ years to retire. We are maxing out our Roth 401ks/IRAs, adding extra cash into a taxable brokerage account. We are 100% invested in equities, mostly index funds with ~16% company stock and <5% for my fun portfolio. The chaotic market hasn’t really been an issue since we have a long time horizon.

What would be the best way to start investing in bonds? One option would be to start buying $10k each in I Bonds starting the next few years until we retire. This would give us income spread out over our retirement, and can get the difference with our equities. If an emergency happens, we can cash it out early, or if we don’t need the income that year we can defer cashing them until the following year.

Another option would be to DCA into Vanguard bond funds starting in our mid-40s. I look at the monthly income on those, and it just seems so low. We’d need to have a lot saved for any meaningful income, so I’m leaning towards the I Bond route. What are we missing?

Investment planning typically focuses on the extreme ends of portfolio management.

Young investors should have the bulk of their portfolio in stocks since they have human capital in spades and decades to save. Retirees should have a more balanced portfolio because they don’t have as much income or time.

These are stereotypes but you get the idea.

However, the glide path from a more aggressive portfolio to a more conservative portfolio doesn’t get nearly as much attention.

I like the idea of dollar cost averaging into bonds over time. In fact, the current rising rate environment is a perfect time to do so.

It’s also wonderful timing to put some money to work in Series I Savings Bonds.

These once-obscure government bonds are now one of the hottest investment products on the market.

According to the Wall Street Journal, yields on I Bonds are fast-approaching 10% and the money is pouring in:

U.S. Treasury Series I Bonds, or I Bonds, will offer annual interest payments of 9.6%, based on the bond’s latest inflation rate calculation, which is tied to March’s consumer-price index.

Over the past six months, nearly $11 billion in I Bonds have been issued, compared with around $1.2 billion during the same period in 2020 and 2021, according to Treasury Department records.

That’s 9.6% annualized for bonds backed by the full faith of the U.S. government.

You will not find a better deal in fixed income right now.

So how does it work?

Here’s the rundown:

  • You buy these bonds straight from the government at Treasury Direct.
  • The yield is computed every 6 months (in May and November) and compounds semi-annually.
  • There is a fixed component (which is currently 0%) and an inflation-indexed component tied to CPI that resets semi-annually.
  • There is a $10,000 limit per person (you can buy them for your kids too) annually.1
  • If you send your tax refund directly to Treasury Direct you can buy an extra $5,000 per year.
  • You don’t pay any state taxes and federal income tax can be deferred until redemption.
  • If you use these bonds to pay for education expenses they are tax-free.
  • You cannot cash in these bonds in the first 12 months.
  • If you cash in before 5 years is up, you pay a penalty of 3 months’ worth of interest.
  • After 5 years you can redeem penalty-free.

This seems like a no-brainer for either fixed income or some sort of intermediate savings goal right now.

The only real downsides are as follows:

  • The Treasury Direct website looks like it was created in 1997 and is not the greatest user experience.
  • It’s not easy to rebalance these bonds.
  • You can’t buy the bonds in a tax-deferred account like an IRA or 401(k).
  • You cannot do joint accounts so both you and your spouse would need to create their own account.

I would imagine the current yield is incentive enough to jump through some hoops to make this one work.

The benefits of using an index fund or ETF are a better user experience, the ability to automate your rebalancing, access to tax-deferred accounts and no limits on the amount you invest (in a taxable account).

Plus, now is a perfect time to dollar cost average into bond funds because interest rates are actually rising for once!

This isn’t a great thing in the short-term if you already own bonds, but if you’re buying them (or holding them for the intermediate or long-term) the expected returns are much higher than they’ve been in recent years.

You can earn 2-3% in relatively “safe” U.S. government bonds right now.

I don’t know if these rates will endure and it’s probable the near-10% Series I Savings Bond yields won’t last either. But the beauty of dollar cost averaging is you can spread out your starting yields so you’re not tied to an arbitrary starting point.

We talked about Series I Savings Bonds on this week’s Portfolio Rescue:

Ben Coulthard also joined me to discuss sidecar accounts, targetdate funds and going from being a saver to a spender.

Podcast version here:

*Have I used the Zoolander meme before? Yes, yes I have. Am I overdoing it? That’s for you to decide but it still makes me laugh all these years later.

1If Biden wanted to score some political points he would increase the cap on these bonds immediately because of the inflation buffer.

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