INDONESIAKININEWS.COM - I Bond yields will reset lower come November. With any investment, asset buyers must think about two things: risk a...
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With any investment, asset buyers must think about two things: risk and return. These days, it appears as if there aren't any risk-free assets anywhere. In fact, even long-term U.S. Treasury Bonds, normally seen as a safe haven hedge against recession, have plunged, with the S&P 10-Year U.S. Treasury Bond index down 16.5% year to date.
The reason for the rare double-digit losses across both stocks and Treasuries in 2022 has been an abrupt change in inflation, along with a corresponding rapid rise in interest rates.
However, there are securities backed by the full faith and credit of the United States, and therefore nearly risk-free, which also protect against the effects of inflation. Moreover, October is the last month in which buyers will be able to derive a 9.62% yield from them, which should far outpace inflation over the next year.
Get to know I Bonds
Treasury Series I savings bonds, or I Bonds, are securities sold by the U.S. government and meant to shield holders from the effects of inflation.
I Bonds are 30-year bonds but can be cashed in sooner with conditions, with a yield that recalibrates every six months according to trailing six-month inflation metrics. The bonds pay out a fixed yield along with a variable rate. Although today's I Bonds have a 0% "real" fixed yield, the variable yield is extremely high today... and those yields won't last long.
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The I Bond variable rate is based on the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) over the prior six months. This rate is slightly different from the seasonally adjusted CPI figure that comes from the Bureau of Labor Statistics, which is the headline inflation metric that gets reported in the media.
The variable rate is reset twice a year: once in May, and once in November. And since the six-month annualized inflation rate between November 2021 and April 2022 was so high, I Bonds currently yield 9.62%. That's an awfully nice yield, even compared with today's higher-than-normal Treasury yields.
However, since inflation has come down in recent months, the new I Bond rate will be reset lower in November. Given the past five months of data, it's projected the new rate will fall to around 6%.
The good news is that if you buy I Bonds before November, buyers will still receive the 9.6% annualized rate for the first six months of ownership before the interest rate resets. That's looking awfully good these days, since inflation should come down soon amid Federal Reserve tightening and a potential economic slowdown.
So what's the catch with I Bonds?
While I Bonds look like a very good deal this month, there are also some limitations and drawbacks to consider.
First, there is a limit to the amount of I Bonds you can buy. The limit is $10,000 per year for individuals, and only $5,000 if you buy the paper bonds (non-electronically).
Moreover, I Bonds cannot be cashed out for at least one year. And if you sell an I Bond before five years, you sacrifice the final three months of interest.
Yet even if one were to incur that penalty, the yield looks attractive today. For instance, if you buy a bond in October and then sell it after one year, you will still receive roughly a 6.31% annualized interest rate, assuming a 6% rate reset in November, and even after sacrificing the final three months' interest.
Even though short-term Treasury rates have skyrocketed this year as the Federal Reserve has raised the federal dunds rate in rapid fashion, the current yield on one-year Treasuries is only 4.03%. So I Bond buyers are still coming out ahead here.
Opportunity vs. opportunity costs
Clearly, if you are near retirement or plan on holding at least $10,000 in cash for at least a year, I Bonds are likely to give you a better return than one-year Treasuries, high-yield savings accounts, or bank certificates of deposit (CDs).
Of course, one other drawback is that you may miss out on even bigger returns by investing in longer-duration assets, such as longer-term Treasuries, corporate bonds, or stocks. We are currently in a bear market right now, which has historically been a great time for long-term investors to buy stocks and bonds of high-quality companies. So investors may be forgoing much bigger gains by tying up their available cash in I Bonds for at least a year. Of course, equities also come with risks, and can move very fast in either direction, as we've seen in 2022.
Amid market turmoil, investors should check their portfolio for both risk and return, and rebalance according to your longer-term objectives. If low-risk assets such as Treasuries are part of that plan, you may want to look at I Bonds before October ends.
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