While Waiting for Rates: I-Bonds

Photo: Philip Brewer

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.

Four Scenarios

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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Guest's picture
David M

I bonds used to be real sweet:

1) You could use your credit card - charge at the end of the month and not have to pay for 60 days or so. Plus get points from the credit card company - flew First class to asia by doing this.

2) The limit used to be $60,000 a year.

3) The guarenteed rate was SWEET - I have gurantees of 3.6%, 3.4%, 3.0% and 2.0% that will keep paying for about 20 more years.

Philip Brewer's picture

Yeah, I've got a couple of I-Bonds from back when the guaranteed rate was 3% or so. That was a sweet deal.

The current low rates aren't a great deal like that, but they are competitive with other rates you can get, combining inflation protection with the option to switch to something else once rates go up.

Guest's picture

Personally, I am waiting until the fix rate increase to 1% or more before I invest. I expect that within 5 years the interest rate will increase so there is no reason for me to get any more I bonds. While I wait, I have my EF is the I bond I have and in a high yield checking account.

Guest's picture

Hey Phillip - a quick question. Until last year, I had been buying 5K of electronic I bonds AND 5K of paper I bonds (from the bank) to total 10K/yr and that was allowed by the feds. You mention that the limit is now 5K. Does that mean you can no longer buy any paper I bonds?

Philip Brewer's picture

Here's the article on purchase limits:


As I read it, what you're doing is fine—there's a separate $5,000 limit on paper and electronic bonds.

In addition, you can do the same thing with Series EE bonds, meaning that you could buy up to $20,000 worth of savings bonds per year. (Although at the moment, I don't see series EE bonds as a particularly good deal.)

Guest's picture
Tracy G

Philip, I thought you might enjoy knowing that I purchased $5,000 in paper I Bonds in November and December 2009 after reading the well-reasoned points in your "Travelers Checks" article. (Our emergency fund is fortunately cushy enough that I could safely purchase the maximum amount at an opportune time.) Neither my husband nor I had owned any I Bonds previously, so they were completely new to us.

We've been pleased with that decision. We previously kept nearly our entire emergency fund in laddered CDs. This is a more diversified approach. I find it reassuring to have the bonds handy for the "bug-out" bag, in case of some catastrophe involving evacuation.

I haven't purchased any since then, however. Like everyone else, I'm watching the fixed rate. (Edit: I originally typed "fixed rat" and caught it proofreading, ha.) If interest rates start to move up significantly, I'll keep in mind your advice to cash in. Makes sense to me, though I think I'll always hang on to a few, as they seem to give me greater peace of mind.

Philip Brewer's picture

If rates go up, it may well make sense to cash in your I bonds. But then it may well make sense to turn right around and invest the money in fresh I bonds!

It's just one of the oddities of an investment that lets you lock in the return for 30 years, while retaining the option to cash the money in after just a year with a small penalty (or after 5 years with no penalty). While rates are rising, you can keep cashing the bonds in and then reinvesting for the higher rate. Once rates peak, hold the bonds you end up with for 30 years.

Guest's picture
Tracy G

Thanks, and I agree that could be the smartest strategy. I will be watching the situation closely to see how it develops!

Guest's picture

I plan on buying 2/ 500 dollar ibonds in mid to late May. I like the strategy of purchasing smaller denominations to provide more flexibility when cashing. Plus if the fixed rate rises quickly or rates in general, I have the option to cash one in early (3mo's penalty) and holding one for the long haul...

Guest's picture
Tracy G

Even though the fixed rate component is stuck at zero, I want to put another $1,000 into these before the end of the month. I think they're too good to pass up at 4.60%. It's theoretically possible they could drop to 0.00% on November 1, 2011. But if that happens, I'll just cash them in early May 2012. There wouldn't even be a penalty (since they'd be earning no interest during those last three months). In that worst case scenario, they'd still return 2.51% over the 11-month period, which is better than I can do with a CD at my local banks.

Guest's picture
David M

Sounds like a great plan!

Guest's picture
Zvi Bodie

The purchase limit has been raised from $5000 t0 $10000 per year per person.

Guest's picture
Tracy G

It's my understanding that paper I-bonds are no longer available, except optionally for IRS tax refunds. The next I-bond rates (for electronic and for paper if you can get it) are trending toward a rate of zero in May 2012, as explained in this update at Savings Bond Advisor.

I'm certainly glad I purchased as many as I did, when I did. I stocked up on a few extra paper I-bonds this past November and December, and probably won't order any more anytime soon.

Guest's picture
david M

That will be interesting - zero for the guarantee and zero for interest - I guess I will not be investing in I bonds in the next 6 month period.

Actually I will not be investing as I have over $200,000 in I bonds purchase in the 7-10 year ago range that have guarantees of between 2% and 3.6% - the good old days for I bond purchases!