Using series I savings bonds as a safe long term investment vehicle
I only recently stumbled upon i bonds (also known as Series I savings bonds) as another investment vehicle. After careful study and making a personal investment in it, I wanted to share some of my acquired knowledge about them. In this post I am going to break down this information into meaningful chunks so you can quickly grasp the idea behind it.
- I - bonds are guaranteed to increase in value every year at least at the rate of inflation.
- Maximum time you can hold an i-bond = 30 years.
- Minimum time you should hold an i bond without any withdrawal penalty - 5 years. (else the withdrawal penalty is the interest of the 3 most recent months).
- The interest is compounded semiannually - every six months from the bond's issue date.
Interest ratesThe entire history of interest rates is available as a downloadable pdf. In general, it seems to be swinging between 1.96 and 2.06 in the past decade or so.
- You don’t pay any state/local taxes on the earned interest. Only federal taxes.
- Taxes are only due at the time of redemption. So you can let your interest compound tax free until then.
- At the time of redemption, it is possible that there might be no tax if the money is used for education purposes.
Interest CalculationThe interest you receive has 2 components - A Fixed rate (which does not change over the life of the investment) - An Inflation rate - Adjusted semi annually to match inflation. Both the fixed rate and inflation rate are re-adjusted once every six months. The difference between the two is that, at the time of investment, the fixed rate that you get is applicable for the lifetime of your investment, while the inflation rate is allowed to change. For example.
Let’s say that at time of purchase your fixed rate is 0.1% and inflation rate is 1.5%. After 6 months, the fixed rate is revised to 0.05% and inflation rate is revised to 1.7%. In the above scenario, your principal will continue to receive the 0.1% fixed rate, along with the newer 1.7% inflation rate.Another important aspect of this investment is that your capital is guaranteed to never decrease, i.e. even if inflation rates are negative in the economy, the worst you would get is a 0% inflation rate. Therefore effectively, your capital will never decrease no matter what.
Factors to consider
- You are only allowed to invest upto $10,000 per year in an series i savings bond.
- The bond cannot be redeemed for the first 12 months after purchase.
- Any withdrawals in the first 5 years incur interest penalty for the 3 most recent months.
Now that you have a basic understanding of i-bonds, here’s are links to the important questions that must be going on in your mind.
How is the author investing in it at the time of writing?Given that I am still taking baby steps towards investment, I plan to invest 5K semi annually whenever the interest rates change to see how it grows. My thinking is, since the fixed rate is revisited every 6 months, it could be better if at least some part of my money is invested in different fixed rates since the fixed rate applies to the lifetime of my investment. Let me know in the comments if you have any alternative suggestions or a feel that there is a better way to distribute the investment in i-bonds.
- Official US Government page for i bonds
- Official US Government page on i bonds rates and terms
- 6 reasons to consider series-i-bonds