Last spring, I introduced Money Talks readers to a simple way to protect a portion of their savings from inflation while taking virtually no investment risk.
I’m referring to Series I savings bonds, or “I bonds” as they’re commonly known.
As I explained, I bonds are a type of savings bond designed to keep up with (or even beat) inflation. (If you missed my full explanation, you can catch up right here.)
In short, unlike traditional Series EE savings bonds, which only pay a fixed interest rate, I bonds pay a “composite” rate that includes both a fixed rate and a rate based on consumer price inflation.
The U.S. government allows individuals to buy up to $15,000 of I bonds each calendar year. (That includes up to $10,000 in electronic bonds and another $5,000 in paper bonds when you file your taxes.)
Because it is January, you’re now eligible to buy additional I bonds, even if you purchased as recently as December.
However, while the basics I explained in that original essay remain the same, there are a couple of things you should keep in mind before buying I bonds in 2023.
First, the current interest rate on these bonds is now a bit lower than when I wrote about them last June.
That’s because the interest rate on I bonds is recalculated twice a year, at the beginning of May and November. And again, these calculations include both a fixed rate (which the U.S. Treasury chooses based on undisclosed criteria) and a variable “semiannual inflation rate” (which is simply the change in the Consumer Price Index [CPI] over the previous six months).
Specifically, the I bond interest rate formula looks like this:
Composite rate = fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)
In May 2022, the fixed rate was 0%, and the semiannual inflation rate in the CPI (from September 2021 through March 2022) was 4.81%. As a result, I bonds were paying an annualized return of 9.62% when I initially mentioned them.
0.00 + (2 x 0.0481) + (0.00 x 0.0481) = 0.0962 = 9.62%
When the Treasury recalculated this rate last November, it increased the fixed rate to 0.4%, while the semiannual inflation rate (from March 2022 through September 2022) fell to 3.24%.
These changes brought the composite rate to 6.89%, as you can see below:
0.0040 + (2 x 0.0324) + (0.0040 x 0.0324) = 0.0689 = 6.89%
That is significantly lower than the previous composite rate. However, it’s still above the current rate of consumer price inflation (6.5% as of December) and well above what you can earn in bank accounts, money market funds, and short-term Treasury bills.
However, this rate will be recalculated again in May.
Based on the recent CPI trend, the new semiannual inflation rate will likely again be lower than in November. But inflation could potentially move higher again, so we won’t know for sure until after the January, February, and March CPI reports are released over the next three months.
So, what should you do with this information?
Well, if your top priority is maximum flexibility with this investment, then your best bet is to buy additional I bonds sooner rather than later.
As I explained last time, investors must hold I bonds for a minimum of 12 months before they can be cashed in or “redeemed.”
That means bonds purchased on or before Jan. 31, 2023, won’t be eligible for redemption until January 2024 (though you’ll still pay a penalty equal to the last three months of interest if you sell in less than five years). And every month you wait to buy is another month you must wait to sell.
However, if you’re looking to maximize the potential interest you can earn on this investment this year, you may want to wait to buy until after the March CPI report is released on April 12.
At that time, we’ll be able to calculate what the new semiannual inflation rate will be on May 1.
You can easily do this yourself using data from the St. Louis Fed’s free “FRED” database and the following formula:
May 2023 semiannual inflation rate = (March 2023 CPI – September 2022 CPI) / September 2022 CPI
If the new semiannual inflation rate is lower than the current rate of 3.24%, as expected, you’ll still have time to take advantage of the current rate.
Remember, while the Treasury recalculates these rates every May and November, the rates on individual I bonds reset every six months from the date of purchase. So long as you purchase before the new rate takes effect on May 1, you’ll still be able to earn the current rate for a full six months (until Oct. 1, 2022) before the new lower rate applies.
On the other hand, if inflation surprises to the upside over the next few months and the new semiannual inflation rate is significantly higher than the current rate, you may prefer to wait. If you make your purchase on (or after) May 1, you can collect that new higher rate for the next six months instead.
Of course, the Treasury could unexpectedly lower the fixed rate again, even if inflation does move significantly higher. So, you could also consider purchasing half your annual limit before May 1 and the other half after to minimize this risk.