What Is An I Bond? Let’s Discuss

We will break down topics such as I Bond Compound Interest, I Bond Rates 2023, I bond history, AND HOW LONG YOU HAVE TO HOLD ON OUR ROAD TO UNDERSTANDING THE INVESTMENT OPTION

Money is like manure. You have to spread it around or it smells." 

- JP Getty

Investing can be a tricky business, and we will start out by saying that this I Bond discussion in no way is a recommendation for people to invest in them. We aim to just give you the information and knowledge around this lessor known investment option and let you do further work if you want to decide if it is right for you.

As a starting point, any time you think about investing your hard earned money, the first question should always be, “what are my goals?”

Starting to answer this question first can help you to better understand what options you have with the money as you will have to honestly answer questions like the following: how long can you afford to have your cash locked up (i.e. unavailable)? How much risk you are willing to take (honestly)? What is the amount of money you really need to live day to day?

After you answer these questions for yourself, it’s time to start think and doing some work around different kinds of investments. As part of this research, we wanted to introduce you to I Bonds as we are betting you have probably never heard of them. First off, don’t worry, you are not alone. Most professional investors don’t even know about (largely because they are not sold through banks and so can’t be used by them to make money off you!).

So as a way of introduction, in this quick 6 minute read, we'll discuss:

1. What are bonds generally, what are different types, and how do they differ from other investments

2. What are I Bonds specifically, how do they work, and why haven’t you heard about them

3. What are the advantages and disadvantages of I Bonds

4. How do you actually to buy them

5. What are some alternative investment options with similar risk profiles

Let’s get started!

What The Heck Are Bonds To Begin With And How Do They Work?

Bonds are a type of investment that in simple terms involve you lending your money to an entity for a set time period with the expectation you will get your money back plus interest (i.e. you are acting kind of like a bank with your money).

Unlike stocks, you do not have any ownership of the entity when you fork over your money for a bond. The bond simply represents an IOU and in most cases you will get your money back plus interest after a certain time period.

Now, there are several different types of bonds and they differ mainly by the entity that is asking for you to lend them money. They include:

1. Government Bonds - These are issued by national governments and are considered to be among the safest types of bonds because they are backed by the full faith and credit of the government (ok, so maybe this last point is debatable when it comes to the government being “safe”).

2. Corporate Bonds - These are issued by companies and are often riskier than government bonds because there is a greater chance that the company may go bankrupt or not be able to pay you back.

3. Municipal Bonds - These are issued by local governments and are often used to finance infrastructure projects like schools and highways in the neighborhood. They are generally considered to be a low-risk investment because they are backed by the taxing authority of the local government (i.e. the local government’s tax revenue is then used to pay you back).

Ok, So What Are I Bonds Specifically And How Do They Work?

I Bonds are savings bonds issued by the U.S. Treasury Department and are perhaps one of the least known or talked about vehicles out there when it comes to bond investing. They were first introduced in 1998 and would be classified as “Government Bonds” above, because you are effectively lending your money to the U.S. Government.

They are sold at face value (Purchased in amounts $25 or more, to the penny) and accrue interest over time. Unlike traditional bonds, I Bonds offer a fixed rate of return combined with an inflation rate that is adjusted twice a year.

The inflation rate is based on the Consumer Price Index for all Urban Consumers (CPI-U) and can go up or down so it allows the return to you get to be constantly adjusted for inflation.

I Bonds have a maturity period of 30 years, but they can be redeemed after 12 months. If you redeem the bond before five years, you will forfeit the three most recent months of interest. After five years, you can redeem the bond without penalty.

Now as noted above, the reason you probably have not heard much about I Bonds is that they are not sold through brokerage accounts (only through the US Treasury Website - more on that below). As such, many professional platforms and investors will not push them on you because 1) they may not have heard of them themselves or 2) they can’t make any money off selling them to you.

Advantages And Disadvantages

Let’s start with the advantages which can be quite substantial for a lot of people, especially when compared with other government bonds or corporate bonds. They are:

• The bonds are not subject to any state or local income tax (you do have to pay federal taxes unless you invest in them through a 529 or other tax sheltered plan - for more on 529 plans and how to set they kids up click here)

• They are indexed for inflation meaning if you are worried about inflation going higher the return you get from the bond will be adjusted for it

• The current rate through April 2023 is 6.89%, this compares favorably to virtually any other short term instrument

• You can invest $10,000 per Social Security number per calendar year

• The interest is paid out to you once the bond matures or you cash it in. In the meantime your return compounds every year from the interest you accrue

Now there are also some disadvantages. Some of those being:

• The bond is not trade-able (i.e. you have to hold it at least a year)

• You will lose 3 months of interest if you try to redeem it in less than 5 years

• The way interest rates are calculated is complex and can sometimes be confusing

• If inflation were to come down the return on the bond would also go down and become less attractive vs. some other options

How To Buy Them

The main way to buy I Bonds is to go online using TreasuryDirect.gov and completing the following steps:

• Open and online account at the link above. On the website’s homepage, select “open a new account” on the right-hand side. Be sure to choose a “TreasuryDirect” account (not a FedInvest or SLGSafe account). After following the prompts, you’ll need to provide your information under penalty of perjury.

• Log into your account. Once your account is fully set up, TreasuryDirect will send you an automated email with your account number. This account number acts as a username. Do not lose or forget it.

• Buy your digital I Bonds. Now that you’re able to open an online account with the Treasury Department and log in without issue, you can buy I bonds fairly easily. From your account dashboard, select the “BuyDirect” tab at the top of the page and choose “Series I” under the “Savings Bonds” section. After that, simply follow the prompts to purchase the amount you want.

Similar Alternatives

As noted above, I Bonds have their pluses and minuses vs. other types of bonds or investments with a similar low risk profile. If you're looking for other bonds specifically that are similar to I Bonds in terms of risk profile, here are three options to consider with more information linked:

1. EE Bonds - Series EE savings bonds are another low-risk way to invest money. They earn interest regularly for 30 years (or until you cash them if you do that before 30 years). One key difference here is they are not adjusted for inflation with a constant rate for the duration of the bond (see a comparison)

2. Treasury Inflation-Protected Securities (TIPS) - Like I Bonds, TIPS are designed to protect investors from inflation by providing a variable interest rate that adjusts with changes in the CPI. They are also backed by the US government, making them a very safe investment option.

3. Municipal Bonds - As mentioned earlier, municipal bonds are often considered to be a low-risk investment because they are backed by the taxing authority of the local government.

4. High-Quality Corporate Bonds - While corporate bonds are generally considered to be riskier than government bonds, high-quality corporate bonds (think Apple or McDonald’s) can still offer a relatively low-risk investment option. These bonds are issued by companies with strong credit ratings and a solid track record of paying their bondholders on time.

Final Thoughts…

I Bonds are a lesser known instrument for even professional investors because they are not as widely advertised and banks can’t earn big commissions on them. For you though, if you are looking for something on the safer side that can help protect against inflation, then maybe I Bonds are worth a look.

We hope this quick summary was at least informative and helpful. Subscribe to our free weekly newsletter below and make sure you never miss our content!