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How Series I Savings Bonds Work

A reader asks:

My husband and I are both over 30 and have 30+ years to retire. We’re maxing out our Roth 401ks/IRA, adding extra cash to a taxable brokerage account. We invest 100% in equities, mostly index funds with ~16% company stocks and <5% for my fun portfolio. Chaotic markets haven't really been an issue as we have a long time horizon.

What would be the best way to start investing in bonds? One option would be to start buying $10k each in I bonds over the next few years until we retire. This will give us the income spread over our retirement, and can receive the difference with our equity. If an emergency occurs, we can redeem it early, or if we don’t need the income that year, we can postpone cashing them out until the next year.

Another option would be to start DCA in a Vanguard bond fund in our mid-40s. I see monthly income on them, and it seems so low. We have to save a lot to have any meaningful income, so I’m leaning towards the i bond route. What are we missing?

Investment planning usually focuses on the extreme end of portfolio management.

Young investors should keep the bulk of their portfolio in stocks because they have the human capital and decades to save. Retirees should have a more balanced portfolio because they don’t have as much income or time.

These are stereotypes but you get the idea.

However, the glide path from a more aggressive portfolio to a more conservative portfolio does not receive as much attention.

I like the idea of ​​making a leap in dollar cost averaging over time. In fact, the current rising rate environment is a perfect time to do so.

This is also a wonderful time to put some money to work in Series I savings bonds.

These once obscure government bonds are now one of the hottest investment products on the market.

According to the Wall Street Journal, yields on I bonds are rapidly approaching 10% and money is coming in:

US Treasury Series I bonds, or I bonds, Will offer 9.6% annual interest paymentBased on the bond’s latest inflation rate calculation, which is tied to the March consumer-price index.

According to Treasury Department records, over the past six months, about $11 billion in I bonds have been issued, compared to about $1.2 billion issued during the same period in 2020 and 2021.

It is 9.6% annualized for bonds backed by the full confidence of the US government.

You will not get a better deal than this in fixed income right now.

So how does it work?

Here’s a rundown:

  • You buy these bonds directly from the government at Treasury Direct.
  • The yield is calculated every 6 months (in May and November) and compounded semi-annually.
  • There is a fixed component (which is currently 0%) and an inflation-indexed component linked to the CPI that resets semi-annually.
  • There is a limit of $10,000 per person (you can also buy them for your kids) annually.1
  • If you send your tax refund directly to Treasury Direct, you can purchase an additional $5,000 per year.
  • You do not pay any state taxes and federal income tax can be deferred until redemption.
  • If you use these bonds to pay for education expenses, they are tax-free.
  • You cannot redeem these bonds in the first 12 months.
  • If you cash in before 5 years, you pay a penalty of 3 months interest.
  • You can redeem penalty-free after 5 years.

It seems like a no-brainer right now for either a fixed income or some sort of intermediate savings goal.

The only real downsides are:

  • The Treasury Direct website looks like it was built in 1997 and doesn’t have the greatest user experience.
  • There is no option to automate these investments.
  • Rebalancing these bonds is not easy.
  • You cannot buy bonds in a tax-deferred account such as an IRA or 401(k).
  • You can’t do joint accounts, so both you and your spouse must create your own account.

Basically, it’s not as easy to automatically invest in something like a workplace retirement account, RoboAdvisor or Vanguard account.

I think the current yield is enough incentive to jump through a few hoops to make this one work.

The benefits of using an index fund or ETF are an improved user experience, the ability to automate your investments and rebalancing, access to tax-deferred accounts, and no limit to the amount you can invest (in a taxable account).

Plus, now is a perfect time to dollar-cost averaging into bond funds because interest rates are actually going up once!

That’s not a great deal in the short term if you already own bonds, but if you’re buying them (or holding them for the intermediate or long term) the expected returns are much higher than they should be. recent years.

You can earn 2-3% in relatively “safe” US government bonds right now.

I don’t know whether these rates will remain in place and it is possible that the Series I savings bond may not yield close to 10%. But the beauty of dollar cost averaging is that you can spread out your starting yield so that you’re not tied to an arbitrary starting point.

We talked about Series I savings bonds on this week’s Portfolio Rescue:

Ben Coulthard also joined me to discuss sidecar accounts, targeting funds, and going from a saver to a spender.

Podcast version here:

*Have I used Zoolander before? Yes, yes I have. am i overdoing it? It’s up to you to decide but it still makes me laugh after all these years.

1If Biden wants to score some political points, he will immediately raise the cap on these bonds because of the inflation buffer.

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