This week’s worse-than-expected inflation report caused turmoil in more than one market, but you only read about one of them.
The market grabbing all the headlines was in stocks as the stock market experienced one of its biggest intraday swings in history following the latest inflation news. After falling more than 500 points immediately after the report was released, the Dow Jones Industrial Average DJIA,
It rose more than 1,300 points to close more than 800 points.
Less noticeable was the ripple of excitement the inflation report caused in the normally stable I-bond market. I-bonds are, of course, US savings bonds whose interest rates are based on the growth rate of the consumer price index. Because of the quirks of how I-bond rates are set, many commentators have jumped at the opportunity now to get a little extra income, provided they act before the end of October.
I think these commenters are making a mountain out of a molehill. While they’re not wrong about the window of opportunity available for the next two weeks, the actual dollars involved are too small to make a real difference to anyone’s retirement.
As Dr. Spock once said of Star Trek, “A difference that makes no difference is no difference.”
But I’m getting ahead of myself.
The window of opportunity to earn a little more income exists because of the interplay between the semi-annual schedule for I-bond returns to reset and the specific semi-annual rate reset schedule you will receive individually when investing in I-bonds. While the I-bond yields themselves are reset by the US Treasury in early May and early November each year, the individual rate reset schedule will be based on the six-month anniversaries of the month you purchased your I-bonds. (Two recent columns that do a good job of detailing these logistics are here and here.)
The bottom line of these logistics: If you buy an I-bond before the end of October, you’ll earn the I-bond rate of 9.62% that the Treasury set last May, and that rate will remain constant for you until the end. March 2023. Given this week’s inflation report, we know that if you wait until November to buy an I-bond rate instead, your rate will be 6.48% by this coming April.
That’s a 3.14 percentage point difference between the exciting 6.48% and 9.62%: Those who buy before the end of October can hold onto that high yield for six months.
Why the extra income is not so great
That much extra income certainly sounds exciting, especially when stocks and regular bonds are in historical bear markets. But again, I don’t think this income gap is that big for a few reasons.
One is that the dollars involved are not very effective. The maximum amount of I-bonds each individual is allowed to purchase in a calendar year is $10,000. The 3.14 percent return difference is $26 more per month. While it’s better than getting poked in the eye, retirement isn’t enough to change your standard of living.
A cost-benefit calculation that runs now versus early November must also take into account what inflation will be next spring. If the six-month I-bond rate is higher than the 6.48% rate set in early November of this year, the additional interest you will earn by investing in I-bonds over the next two weeks will be equal. as low as $26 per month.
There is another consideration. The I-bond yield is actually the sum of two individual rates: the Inflation-adjustment factor and the fixed rate. This fixed rate is currently zero, but I’m willing to bet that will change in early November. That’s because Treasury Inflation-Protected Securities (TIPS), the closest competitor to I-Bonds, currently trade at a higher yield than inflation. 5-year TIPS TMUBMUSD05Y,
for example, sports a real yield of 1.80%, which is much more attractive than a fixed rate 0% I-bond.
It is understandable why the US Treasury set the I-bond fixed rate at 0% in previous years, since TIPS yields were negative at the time. But now that TIPS yields have turned significantly positive, the fixed rate of I-bonds must rise to remain competitive. While there’s no way to know if the U.S. Treasury will actually raise the I-bond rate in early November, The Finance Buff’s Harry Sit noted in an email that he would be “disappointed” if they don’t.
If the Treasury raises this fixed-rate component, then you’ll be out front by waiting until November to buy any I-bonds. That’s because the fixed rate you’ll earn by waiting will more than make up for any lower inflation adjustment factor. The fixed rate you get when you invest in I-bonds stays in place for as long as you hold them (up to a maximum of 30 years), while the higher rate you lock in by taking action in the next two weeks lasts just six years. month So by waiting until November and giving up $26 in monthly interest over six months, you’ll likely lock in a non-zero fixed rate for 30 years.
So waiting seems like a good bet to me.
TIPS and I-bonds
As this discussion shows, TIPS have become competitive with I-Bonds in recent months, if not more so, as TIPS now trade at a high positive real yield. An added advantage of TIPS is that there are no trading limits, so they have the potential to make a real difference to your retirement lifestyle.
TIPS have some downside risks, but I discussed them in a recent Retirement Week column. As always, it’s a good idea to discuss your various options with a qualified retirement financial planner.
But it would be a mistake to think that you only have two weeks to decide. I-bonds can be very attractive additions to your retirement portfolio, but only as part of a long-term financial plan of gradual accumulation. They are not a short-term trading tool.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings track investment newsletters that pay a flat fee for verification. He can be reached at firstname.lastname@example.org.