Put away the party hats, November’s I bond announcement will be a less than momentous occasion. Rate expectations for the new I bond are very low.
“I expect the new rate will be below 1 percent, possibly 0.8 percent or 0.9 percent. That is based on my expectation of the fixed return component at 0.1 percent or 0.2 percent and a 0.74 percent annualized rate of change in the CPI,” says Greg McBride, CFA, Bankrate senior financial analyst.
The I bond is a 30-year inflation-fighting savings bond issued by the government to help savers hang on to their buying power.
The earnings rate on the I bond is based on two numbers. The first is a fixed rate; the second is a variable rate.
A new fixed rate will be announced Nov. 1. That rate will apply to all I bonds issued between November and May, and it will stick with the bond throughout its 30-year life span. In May, a new fixed rate is announced that will be applied to I bonds issued May through November.
The variable rate component changes every six months. A new variable rate is announced in May and November based on inflation changes during the previous six-month period and is applied to all outstanding I bonds.
In calculating the variable rate, the Treasury looks at the unadjusted U.S. Consumer Price Index for All Urban Consumers, or the CPI-U. For the November rate announcement, the clock started ticking in March, with an index of 217.631. It ended with an index for September of 218.439, which equals a six-month increase of 0.37 percent.
The six-month percentage change is doubled to get the annualized rate of change in the U.S. Consumer Price Index and the new I bond variable rate.
Time to buy?
If you’re considering an I-bond purchase, it may make sense to buy before November’s rate announcement.
“I would probably invest a little more prior to the November date, but you’re probably flipping a coin at this point,” says Herbert Hopwood, CFP, president of Hopwood Financial Services in Great Falls, Va.
The fixed component in the earnings rate of the new I bond will likely be close to the spring rate, 0.2 percent. McBride expects 0.1 percent or 0.2 percent.
However, November’s variable rate, also known as the inflation rate, will be less than half of what it was in the I bond spring series, at 0.74 percent.
I bonds bought before Nov. 1 will have the higher variable rate of 1.54 percent for six months. After six months, November’s variable rate will be applied. For those who buy I bonds after Nov. 1, the new rate will be applied.
There are a couple of reasons that I bonds may not be the best investment these days.
An extremely low fixed rate for 30 years. I bonds issued between 2008 and the present have had extremely low fixed rates. That hasn’t always been the case. According to TreasuryDirect.gov, between 1998, when the I bond debuted, and 2001, the fixed rate was north of 3 percent.
“With inflation worries on the back burner for the near term, there is very little inflation compensation, even on five-year TIPS (Treasury Inflation-Protected Securities),” McBride says. “I bonds are unappealing.”
I bonds can be redeemed without penalty after five years.
After the housing crisis, the Consumer Price Index may not be the truest reading of inflation.
Housing is weighted heavily in the index, and accounts for about 42 percent of it. But housing costs may not keep pace with inflation, due to the supply of homes.
“My argument is that we have a tremendous housing supply available. The supply will far outweigh the demand for years,” says Donald Cummings Jr., managing partner at Blue Haven Capital in Geneva, Ill.
“When inflation comes, we’ll see food prices go up. Energy, precious metals and industrial metals will all go up. But, I don’t think we’re going to see housing prices go up for 10 years to 15 years,” he says.
In other words, because housing makes up such a large part of the index, it might not be the best barometer for the actual price increases that consumers are paying. That means that the I bond won’t be doing its job of protecting consumer purchasing power.
Alternative hedges against inflation
There are other investments to consider as a hedge against inflation. Cummings recommends a commodity index exchange-traded fund, or ETF.
McBride also offers some options to I bonds in the current environment.
“Better inflation hedges are longer-term Treasury Inflation-Protected Securities such as the 10-year TIPS. And other asset classes such as dividend-paying stocks, REITs, commodities and other real assets, although there aren’t any screaming values in that group,” he says. The caveat is that other asset classes can be much more risky than the Treasury-backed I bond.
The I bond can’t be redeemed at all during the first year and if you redeem it within the first five years, you forfeit the last three months’ worth of interest.
Despite the downsides, the best thing about I bonds is their safety: They can never lose money. The other government-issued inflation hedge, TIPS, can lose money unless they’re bought at auction, says Hopwood.
Interest earned on I bonds is also free of state and local taxes. Plus, federal taxes can be deferred until maturity, or interest can be reported yearly. There are also tax benefits to using I bonds to finance education. Those factors, plus an inflation-beating yield guaranteed for 30 years, are worth it for many investors.