Series I Savings Bonds

Investing in Series I Savings Bonds: A Way to Earn 7.12% Returns?

The conventional wisdom about wealth management is that bonds don’t offer a return high enough to beat inflation, so investors are better off filling their portfolios with funds instead. But the numbers suggest otherwise for a particular type of bond — the return for Series I savings bonds issued between November 2021 and April 2022 is 7.12%. And no, that decimal place isn’t supposed to go before the number seven.

In the current climate, even the best high-yield savings accounts will barely net you more than what you’d get if you left your money under your mattress, so Series I savings bonds seem like a good bet. But before you invest, you need to understand how they work. 

To fill you in, we’ll cover:

  • What you need to know about bonds and how they work
  • The specifics of Series I savings bonds
  • Their historical returns
  • Pros and cons of investing in savings bonds
  • How to manage a diversified portfolio

How bonds work

Are you confused about what you’re actually investing in when you buy bonds? You’re not the only one, so let’s take a few moments to break it down.

Bonds are debt securities — as the investor, you’re acting as a lender to whoever buys the bond (usually a company or the government). In return for you lending them the money upfront, they promise to pay you interest, in addition to giving you the full amount invested back eventually.

This might sound like a risky prospect — what if the borrower never pays you back? But in the case of bonds, borrowers are usually far more reliable than those you’d encounter in peer-to-peer lending or if you were lending to your friends. As a result, bonds are generally viewed as being one of the most conservative investment options around. More so than even index funds.

Interest rates and inflation

One of the most important things to know about bonds is that they move in the opposite direction to interest rates. When the Fed raises rates, bond returns fall, and vice versa. Why? Because when you take out bonds, you sign up for a fixed interest rate at the start of your term.

So, when interest rates decrease, it stimulates spending and results in price inflation —meaning the interest rates you signed up to will seem lower in real terms. The value of the bond itself will also effectively decrease — any future payments you get will be worth less since inflation will erode their value. If you buy a $1,000 bond that offers 1% annual interest but the inflation rate that year ended up being 2%, guess what? You just lost money.

Fortunately, as you’ll soon see, some exceptions overcome this problem.

Types of bonds

Although most people talk about bonds as though they’re one unified front, there are a few different types of bonds to be aware of. 

For one, there are corporate bonds (when you’re lending to companies), municipal bonds (when you’re lending to state or local governments), and treasury bonds (issued by the U.S. Department of the Treasury to fund the government). 

Treasury bonds are generally seen as the most conservative type of all since the government has always proven to be a very reliable borrower, while corporate bonds can be riskier.

But the distinctions between different bond types don’t end there. In this article, we’re focusing on Series I bonds, a type of government savings bond. However, they’re special because they offer a combined interest rate that combines a fixed rate and inflation. 

Spotlight on Series I bonds

Let’s explain this a little better. When you invest in Series I bonds, you can expect the standard fixed-rate return you’d get from any other bond. However, there’s an additional rate that’s adjusted twice a year depending on the inflation rate (or, more precisely, the Consumer Price Index for all Urban Consumers, one measure of many). 

The final rate combines both of these, and as a result, you’ll be more protected against inflation.

The minimum purchase for a Series I savings bond is $25, and the maximum you can put into them is $10,000 each year. Beyond this, you can invest any amount under the sun — even something oddly specific like $3,761.41.

It takes 30 years for the bonds to reach maturity, but you can cash them in within five years with no penalty. However, there is a small penalty if you cash in sooner.

Other than this, it’s all pretty simple. You can buy the bonds at face value from the TreasuryDirect website, and you’ll receive your interest payments every month. Bear in mind that they’re non-marketable, which means you can’t buy or sell them on secondary markets — TreasuryDirect only.

But before you invest a significant sum, you’ll probably want a more comprehensive analysis.

Historic savings bond returns 

We know that you’ll want to find out how bonds of this type have performed historically — have they always offered 7.12% a year? Let’s take a look at how the returns have changed over time.

This might surprise you, but actually, yes (just about).

Data taken from: https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm 

As you can see from the chart above, interest rates have remained pretty constant over the last couple of decades, although they have been creeping up. You can also find a more comprehensive chart of how rates have changed over time on the Treasury website.

But before you get overexcited, bear in mind that US inflation was 6.2% between October 2020 and October 2021, so the return isn’t quite as impressive as it looks at first. It’s still better than most of the alternatives, though.

Usually, savings bonds are put into the same category as certificates of deposit (CD) and high-yield savings accounts since all three options are low-risk. However, returns for savings bonds are currently much better. The best rate offered for a high-yield savings account is around 0.6%  at the moment. Meanwhile, CDs are offering just 0.14% on average for a 1-year CD, or 0.26% for a 5-year CD.

These rates are nowhere near high enough to beat inflation. So, whichever way you look at it, Series I savings bonds seem attractive.

Pros of savings bonds

We’ve already established that earning over 7% a year interest with minimal risk makes Series I savings bonds a steal, but this isn’t even the only advantage of investing in them. Here are a few more to feast on.

Low risk

Bonds involve less risk than most other investment options, and Series I savings bonds are no exceptions. This means they do a great job of keeping a portfolio’s value stable over time — in general, experts advise savers to put more of their money into bonds as they get older since it’s more likely they’ll have to use them to fund their retirement. 

As mentioned already, the inflation risk is significant for bonds — especially if you sign up to a fixed interest rate for years into the future. Given many expect Fed rates to rise in 2022 and for inflation to continue increasing, it’s reasonable to expect that bond returns might decrease in real terms. But since Series I bonds get around this problem, they play a more important role for investors than ever.

Regular payments

Savings bonds offer regular and predictable payments each month rather than fluctuating based on factors that are outside of your control. Need we say more?

Tax-efficient

They’re also tax-efficient. 

Although you have to pay federal income tax on Series I bonds, you can avoid this if you use your earnings to pay for higher education. They make a great choice for parents trying to save for their children to go to college or those who want to give a good gift to minors, who are allowed to hold savings bonds in their own name (which isn’t the same with other securities).

Also, note that you won’t face tax at the state or local level and that you won’t be taxed on your interest until you actually cash in your bond.

Cons of savings bonds 

Clearly, bonds have plenty going for them — but they’re not perfect. Here’s a selection of the key limitations you should be aware of before you get too excited.

Other assets offer greater returns

Although the returns for savings bonds seem high at the moment, they still lag behind other assets. The S&P 500 increased by 24.3% over 2020, and don’t even get us started on cryptocurrencies.

Plus, bonds aren’t the only asset that can hedge against inflation. Precious metals and real estate may also be able to do this, and they often provide better returns if you can put up with the volatility.

Limitations on how much you can buy

Investors with larger portfolios may find that only being able to buy a maximum of $10,000 a year is too much of a limitation. If you want to put 20% of your portfolio into bonds but have a net worth of $500,000, then clearly you have a problem there.

In general, savings bonds are best for people with lower incomes or net worths, but every investor should decide for themselves.

However, some might benefit from the fact that married couples can buy up to $20,000 together as a unit.

Limited flexibility

Once you buy Series I bonds, you won’t be able to access your funds for another 12 months — and then there’s the penalty of losing three months of interest if you decide to withdraw five years before. That’s quite a long period to sign up for in advance.

Plus, you can’t invest in savings bonds through an IRA or 401(k) plan or various other retirement accounts, which limits you further.

Managing a diversified portfolio

So, if there are both pros and cons of investing in bonds, what should you do? For most people, the solution is investing in bonds as part of a diversified portfolio that also contains other assets. Experts generally recommend keeping around 25% of your portfolio in bonds at the most (with possible exceptions for those who are retired).

But when you’re managing a portfolio with various asset classes, it can be tough to keep track of how they’re performing and whether you need to tweak your allocation. After all, when stocks and similar assets fall or rise drastically, it changes the allocation.

Fortunately, there’s a solution: using a portfolio tracker that can connect to various accounts containing various investments and allow you to manage everything in one place.

Using Money Minx to track your portfolio

Money Minx is an industry-leading portfolio tracker that allows you to add all your accounts and view them on a dashboard that looks something like this:

You can add both liabilities like credit cards and investment assets such as index funds and bonds to get a clearer picture of how your portfolio and net worth are doing. Why log onto many different accounts when you could view everything in a single aesthetically pleasing visualizer?

Perhaps most importantly of all, there’s an allocation tab that shows you how your allocation has changed over time. In the example below, the answer is “not very much at all” — but if your cryptocurrencies (for example) have outperformed your bonds one year and your graph reflects that, it shows that it’s time to sell some crypto and use it buy bonds so you can maintain the risk level you’re comfortable with.

It’s bonds, Series I savings bonds

Bond returns have now reached the point where even those who might have avoided them before are realizing they could offer some real value to their portfolio. With inflation coming at us hard, there’s never been a better time to invest in an asset that actually considers the inflation rate when calculating returns.

But don’t forget to track your investments and continually check your allocation is still working for you (as all bondholders should).

If you really care about diversifying, Money Minx is the ideal choice — it’s unique for allowing you to connect more than 16,000 different accounts to the platform and view them all in one dashboard. It’s an invaluable resource, and all it takes to set it up is a few minutes to enter your passwords and make those connections. You can create your account for free, allowing you to add most non-crypto accounts. Why not give it a go?

Sarah Bromley is a personal finance and fintech writer based in the U.K.

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