What if you could get stock market returns, guaranteed?
The treasury has officially announced the new interest rate for their Savings I Bonds: An annualized rate of 9.62%!!!
For context, the average rate of return in the stock market is just over 10%. And in order to get that return, you need to take on lots of risk, including the possibility of large losses during major events like we experienced during the start of the pandemic.
During times of high inflation, these Savings I Bonds are one of the best ways to protect your purchasing power.
Here’s all you need to know about them.
What are Savings Bonds?
Let’s start from the beginning: A bond is a debt. Just like you can take a loan out from the bank, and you’ll pay the bank interest, a bond is when you lend money to a company or a government.
The US Government offers different kinds of bonds – treasury bonds, and savings bonds.
Treasury bonds usually dominate the news. These bonds are purchased through auction. What does this mean?
Let’s imagine this scenario: A $100 bond with a 5% interest rate. This means you’ll get $2.50 ever six months. But what happens if, in order to win that bond, you have to bid $110? You’ll still be receiving $2.50 every six months, and that translates to an interest rate of 4.55%.
Savings Bonds are different, however.
How do Savings Bonds work?
Savings bonds aren’t purchased at auction – they’re simply purchased at face value. This takes away a lot of uncertainty.
Of these, there is one kind called a Series I Bond. You can think that I stands for “Inflation.”
Photo by Sean Robertson on Unsplash
These bonds have a fixed interest rate (usually pretty low, at or near 0%), and a variable interest rate that is adjusted every six months to the rate of inflation. That makes these an incredibly powerful tool to protect your purchasing power from the eroding effect of inflation.
The latest interest rate announced for bonds purchased May 1 – November 1, 2022, is 4.81% for the first six months. At that point, the interest rate will once again be adjusted to the rate of inflation for the following six months.
In a time when savings accounts have extremely low interest rates, when the stock market is very volatile, and when inflation is so high, this is becoming an incredibly powerful tool.
However, if it’s that powerful, there are probably a few restrictions.
Limitations of Savings I Bonds
There are a few things to bear in mind when purchasing Savings Bonds.
First, you can only buy $10,000 in Savings Bonds per individual per year. This isn’t something to be too sad about – if there are limits being put on tools like this, it means it’s too good for you!
Second, you can’t sell your Savings Bonds for one year. This means that you shouldn’t put money in there that you might need to cover emergencies or surprises within the next year. Are you thinking of buying a house in three months, and you’re low on cash? This might not be the right time for you to use this tool.
Third, if you sell the Savings Bonds before you’ve owned them for 5 years, you will lose 3 months of interest. For this reason, to get the most out of these bonds, it’s best to have a longer time horizon than 5 years before you need to use the money. However, with interest rates as high as they are now, even if you sell after a year, you’ll still be getting a better interest rate than is available in savings accounts!
Fourth, it’s important to remember that the interest rate is adjusted every six months. Inflation will probably remain high for at least a year, but it’s also possible that if inflation suddenly takes a nosedive that the interest rate will also go down in six months. Again, however, even if the inflation-based interest rate drops to zero, you’ll still get 4.81% interest by the end of the first year, many times more than you’d get in a typical savings account.
How do you buy savings bonds?
Savings I bonds have to be purchased through the government site. Go to TreasuryDirect.gov and set up an account for yourself. From there, you’ll need to decide how many bonds you’ll want to buy.
How much should you buy? The answer to that is every financial advisor’s favorite word: depends. The amount of savings bonds that you should buy depends on factors such as income, expenses, current savings, time horizon, risk tolerance, etc.
If you’re interested in finding out more about how Savings Bonds could help you reach your financial goals, sign up for a free Bronze account here. A licensed financial advisor will reach out to help you make the best use of this exciting tool.