Series I bonds: new fixed rate of 0.4% and compound rate of 6.89%
The Series I bond rate resets on May 1 and November 1. For the next 6-month period beginning November 1, 2022, the US Treasury has set the new fixed Series I bond rate at 0.4%, bringing the composite rate for new issues during the period at 6.89%. This includes an inflation-adjusted rate of 6.48% that applies to all previously purchased I Bonds.
If you are wondering how the composite rate is calculated, the equation according to the CashDirect the site says:
Composite rate formula = [Fixed rate + (2 x semiannual inflation rate) + (fixed rate x semiannual inflation rate)]
The calculation for this issue period looks like this:
[0.0040 + (2 x 0.0324) + (0.0040 x 0.0324)] = 0.0689296
The increase in the fixed rate and the simultaneous decrease in the adjustable rate changes the investment thesis of the I bonds. Sometimes the savings bond is a good investment. All other times it is simply a form of savings. Last month, my I Bond strategy was about investing. Today, this thesis is changing.
Summary of Series I Bonds
Series I Savings Bonds offered by the US Treasury are 30-year floating rate bonds that pay interest at a combination of a fixed rate set at issuance and a floating rate determined every 6 months equal to the change in consumer price not adjusted for seasonal variations. Index for all experienced urban consumers in the previous 6-month period.
An important advantage of I bonds is that the interest rate does not fall below zero. If deflation occurs, which means that the CPI goes down, the combination of a negative inflation-adjusted rate and a positive fixed rate may go down but cannot go below zero. This means that the principle on I bonds does not decrease and the worst return that can be experienced is 0%. Interest is earned monthly and compounded semi-annually. Like all Treasury securities, I bonds are guaranteed by the US federal government.
Although I bonds have a term of 30 years, they can be redeemed after 12 months with penalty. If bond I is repaid within the first 5 years, a penalty is imposed on the last 3 months of interest earned. In my last article on bonds I I described my strategy of using I bonds to earn a 6.4% return over the next 12 months after the penalty was imposed. This is higher than current 6-month, 1-year and 2-year Treasury bond rates by almost 2%.
For more information on I Bonds, please visit the TreasuryDirect website.
Saving or investment
Individuals are limited to purchasing $10,000 of I Bonds each year, with the following exceptions:
- An additional $5,000 of paper I bonds can be purchased through tax refunds.
- I bonds can be gifted to others, but count towards the annual limit when received/delivered.
- Entities can purchase I bonds.
I do not discuss these options in detail because they are not part of my I Bond strategy. For my portfolio, the limit of $10,000 per year is sufficient, between my spouse and me. This is because, in my opinion, there is a difference between saving and investing.
Savings include liquid assets that generate a modest return and are strongly protected against loss of capital.
Investment includes assets expected to generate cash flows or returns in excess of inflation which generally involve an element of risk of loss of capital.
By definition, I bonds are intended only to keep pace with inflation. This inflation is calculated by the CPI, which, in my opinion, strongly underestimates the real inflation. Without diving into the subject in detail, it seems implausible that the CPI rose by 1/2 to 1/4 of significant inflation indicators, including the price of gold, house prices and money supply M2. You can explore the subject further all alone.
The point is that I bonds are almost guaranteed to experience real loss of purchasing power over the long term, unless the fixed rate component of the composite rate is large or deflation persists. Neither has been the case for the past 20 years.
For these reasons, I generally use I bonds as a form of savings and occasionally using I bonds as a 1-2 year bond investment, as I described in September. Similarly, an unusual number of investors piled into bonds I end of October to take advantage of the compound rate of 9.62% before it expires. Although I’m fine with the move, I can’t help but think about their investment plan. Will they consider keeping these bonds I indefinitely? How much of their portfolio is allocated to I bonds?
It’s easy to see last month’s 9.62% sticker rate and reassemble the truck. But the rate is temporary and only applies to half a year of interest. He offered an attractive offer invest opportunity that was the product of negative real rates on US Treasuries and a tightening of monetary policy that lowered the opportunity cost of other assets below the threshold that made I bonds attractive. Going forward, the attractiveness of I bonds as an investment diminishes.
This is because the adjustable I bond rate is falling. There is a high probability that the next 6 month period will see no inflation or even deflation. Below is a chart of commons price inflation. Notice how the momentum of price inflation changes in used cars, gasoline, meat, clothing, and all items. With monetary easing and fiscal stimulus behind us, I expect this momentum to continue to wane unless the current policy stance changes.
The table below shows how the fixed rate and the adjustable rate have changed since 2015. It includes a column that represents the total return of a 1-year investment in I bonds issued during this period, including the penalty early repayment. The total return for the period from November 1, 2022 assumes a composite rate of 0% for the next 6-month period, which represents the worst-case scenario. When the total return is higher than the 1-year treasury, I tend to favor series I bonds as an investment.
|Date range||Fixed rate for new bonds issued||Adjustable inflation rate for a period of 6 months||Annualized inflation rate for a period of 6 months||Total return on investment over 1 year|
My strategy for buying I bonds is again focused on savings. For this, I will use a rolling technique based on the fixed rate offered. If the fixed rate of the new issues sees a slight improvement over the fixed rate of my existing I bonds, I will redeem the I bonds and replace them with higher fixed rate I bonds.
This is represented in the table below. The yellow areas represent reversals that I will consider based on other factors. The green area represents the rollovers that I will definitely perform. The values do not include compound interest which would slightly reduce each period of profitability.
My goal is to maintain 50% annual living expenses in I bonds as an alternative to traditional savings accounts that have yielded next to nothing. Of this amount, I want at least 50% to be refundable at any time. This is easily achieved with the annual limit of $10,000 per person.
The US Treasury raised the fixed rate on Series I bonds to 0.4%. This is the highest fixed rate for three years. It reinforces the characteristics of I bonds to fulfill the savings role. But the adjustable rate fell to 6.48%. This undermines the bond investment use case I. Since 1 year Treasury rates are at 4.5% and I expect inflation to come down significantly, I’m not looking at not I bonds as an investment at this time. Instead, I will be working on rolling over my I Bond savings to take advantage of the higher fixed rate.