While Waiting for Rates: I-Bonds
Your short-term cash in a savings account or money fund isn't earning much yield. You could earn a bit more by locking your money up for a longer term, but that could be costly if your money is still locked-in when rates eventually do rise—and especially costly if inflation goes up.
If only there were some instrument that paid a reasonable return, provided some inflation protection, and still gave you access to your money if rates went up.
As you'll have guessed from the title, there is: the series-I savings bond.
The I-Bond provides excellent inflation protection, by paying a rate that consists of a portion that's fixed for the life of the bond, plus a portion that changes every six months based on recent inflation. A bond you buy right now will only pay the inflation rate, because the fixed portion is zero. However, there'll be a new fixed rate announced May 1st.
The I-Bond does this while providing considerable flexibility for you to decide how long you want to leave your money in. If it's providing a good return, you can choose to leave your money in for 30 years. Alternatively, you can take your money out any time after one year has passed. If it's been less than 5 years, you forfeit the last three months interest payments—but since rates are so low, that's not much of a penalty.
There are four scenarios that you need to consider: interest rates might stay low or they might go up; at the same time the inflation rate might stay low or it might go up. Let's look at each of those in turn, and see how the I-Bond works in that scenario.
Rates stay low, inflation stays low
This is basically the situation we've been in since the financial crisis began. The I-Bond is an adequate investment, keeping you even with inflation.
Your best move: Hold your bonds. With low rates, you probably can't do better elsewhere anyway.
Rates go up, inflation stays low
This seems like the least likely scenario, but if this is what happens, you'd be okay.
Your best move: Cash in your bonds and then invest in something paying the new higher rates. You'll have to give up three month's interest—but since inflation is low, that wouldn't be much.
Rates stay low, inflation goes up
This is generally the worst situation for the saver, but the I-Bond does a reasonably good job of protecting you, and you can't do much better elsewhere anyway. (People who locked in their money at low rates without inflation protection, on the other hand, are screwed.)
Your best move: Hold your bonds and keep up with inflation.
Both interest rates and inflation go up
In this scenario you're protected from the inflation, but you're not earning the new higher rates.
Your best move: Cash in your bonds. You'll pay a penalty, but it will be small (as long as you do it early, before you'd earned much of the new, higher inflation adjustment). Then reinvest at the higher rates.
Take Your Time
Probably the best move overall is to adopt this strategy gradually. For one thing, since you can't get your money out for the first year, you don't want to put in any money that you might need during that time. In any case, you're only allowed to buy $5000 worth of savings bonds per year anyway.
If you make a modest investment into I-Bonds each year, all but the most recent batch will be available to cash in anytime that's the right move. And, once five years have passed, some of them will be available to cash in with no penalty.
In fact, once you reach that point, you can start thinking of your savings bonds as part of your emergency fund. They can be cashed in at any bank, so they're almost like cash. (But they're more secure than cash, because if they're lost, stolen, or destroyed, you can get them replaced.)
If you want to invest larger amounts, consider TIPS. They're currently paying higher rates. (However, they don't have the feature of allowing you to cash them in early.) I wrote an article comparing TIPS and I-Bonds a while ago.
See the Treasury's site on I-Bonds for all the details on current rates, how the rate is calculated, how to buy them, etc.
It's entirely possible that interest rates will stay low. In fact, the Fed is pretty much promising to keep rates low for "an extended period." That's assumed to mean at least six months, but it could be much longer than that. I-Bonds are a reasonable choice while you're waiting—and after May 1st, depending on what the Treasury sets as the new fixed rate, they might get better.
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