The recent drop in interest rates for Series I savings bonds (inflation bonds) to 3.8% marks a significant shift that further diminishes their appeal to investors in our opinion. This reduction has made I Bonds less competitive compared to other fixed-income investments available in the marketplace.
In 2021 and 2022, we were recommending them, but warned that the high interest rates would not last and they would likely be unattractive in a few years. Why? Inflation likely was going to come down from the unusual circumstances caused by the pandemic. There was no way that the Federal Reserve would allow inflation to exceed 6% or more. And once the supply chain was fixed, inflation came down to ~3%, although slowly. I Bond interest rates are variable and change every 6 months, reflecting current inflation. I Bonds were great longer-term investments as late as the early 2000s when the fixed rate of 3.6% was added to the inflation rate. However, the fixed rate today is only 1.10%. Not so attractive! When you add inflation of 2.7%, that gives you an I Bond interest rate of 3.8%. Worse than short-term treasury bills with much less liquidity.
Investors seeking reliable income may find better options in various fixed-income securities, such as tax-free municipal bonds. For example, some California issues are paying an interest rate of 4.86% and that’s tax-free. The equivalent taxable yield is 8.20% in the highest California tax bracket (*using 40.8% federal tax rate, including 3.8% Net Investment Income Tax, and maximum state income tax rate).
Additionally, the liquidity and accessibility of these fixed-income investments can address common investor concerns. Unlike I Bonds, which require a minimum holding period of one year and impose penalties for early redemption (forfeit 3-months of interest if redeemed within 5 years), many other fixed-income products can be accessed more readily, providing greater flexibility during times of financial need.
In summary, the decrease in I Bonds interest rates combined with the availability of more attractive fixed-income investments, such as tax-free municipal bonds and higher-yielding short-term Treasury securities, contribute to an increasingly unfavorable outlook for I Bonds. Investors are likely to seek out more lucrative alternatives, making I Bonds a less attractive option in today’s dynamic economic environment. For those that bought them back in 2021/2022 when we were recommending them, should consider liquidating the positions and reinvesting them accordingly. Please speak with your BFSG financial advisor about your specific situation.
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