US Treasury I Bonds – Not a Panacea

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There is a great instinct to try to distill complex investment matters into simple solutions. For years, online experts insisted that you could get all the benefits of the market by just investing in one index like the S&P 500. Now that the shine of US large cap growth is wearing off, a new reductionist approach is gaining traction- US Treasury Series I Savings Bonds, or “I Bonds.”  The siren song is simple- why expose yourself to the ups and downs of the stock market if you can buy a principal-protected investment with a current high yield? How could anyone disagree?

There’s nothing wrong with I Bonds, but there are good reasons why they’re not a substitute for your diversified portfolio – or even your bonds and cash:

  • Your rate on these bonds is CPI for Urban Consumers, so technically you only just keep up with inflation. Generally, the purpose of an investment portfolio is to achieve returns in excess of inflation in the long run- these bonds won’t help do that unless you can perfectly time the market. If you could perfectly time the market, you’d probably invest in much more exciting things than I Bonds!
  • The interest is taxable, so by buying these currently you’re locking in a slight loss after inflation in real dollars- you’re technically losing purchasing power.
  • The current yield is attractive at 9.6%, however it will almost certainly not persist this high. The rate resets every six months.  You have to hold for at least a year, and if you redeem before 5 years, you lose three months of interest. I Bonds aren’t even great for an emergency fund due to that one year lockup, and it’s very likely you will get less than 9.6% holding for one year when the second six month rate (and early withdrawal penalty) is factored in.
  • If we all had unlimited time horizons and no short term cash needs, we probably wouldn’t own any bonds. One of the main reasons to buy bonds is so that if stocks drop significantly, yields are likely to fall and bond prices go up.  Since these are floating rate bonds, you don’t get that potential increase in your bond price, which is a reason it’s not a substitute for a traditional diversified bond allocation. 
  • You can only put $10,000 a year into I Bonds per person, so chasing this high interest rate means you’re only hoping to make hundreds of dollars (not even $1000) the first year.  By the time you can put more money in, yields probably won’t look this good. For investors with larger portfolios, I Bonds won’t make much difference. If $10,000 is most of your portfolio you’re probably younger and should not be nearly 100% bonds to begin with!

There’s nothing wrong with I Bonds, they just aren’t the panacea that some would have you believe. At the end of the day, it’s hard to imagine a long-term scenario where an investor would be better off buying I Bonds rather than adding to a well-planned diversified portfolio. There will always be one size fits all investment ideas, but in the end, we believe it’s worth navigating a little complexity to make the best decisions toward a secure financial future.

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