If you’re not comfortable with stock market volatility but still want a high return, Series I bonds could be a smart addition to your portfolio.
The Series I bonds got some buzz when the United States Department of the Treasury announced a combined 7.12% annual rate from November 2021-April 2022 for the inflation-protected and low-risk investment. This is an increase from the annual return average for long-term government bonds, at 5%-6% since 1926, and brings the rate closer to that of large stocks, which have returned almost 10% annually during that period, according to Morningstar Direct.
So are Series I bonds a better investment for you than the stock market right now? They could work well as part of a diversified mix, experts say, but the two investments serve different purposes. Your ultimate goal should be to find the right mix of the two. Here are some things to keep in mind.
What’s the Difference Between Stocks and Bonds?
A savings bond is a loan you make to a government, municipality, or corporation. (Specifically with the Series I bond, this is a loan to the U.S. government.) You can think of bonds as an IOU with a set maturity date. A stock, on the other hand, is a share of a company. You can invest in individual stocks or mutual funds or ETFs, which are baskets of securities.
Another difference is how you purchase bonds or stocks. Unlike purchasing stocks, which you can do through a stock brokerage, you’ll purchase government bonds from the TreasuryDirect site. “You can literally go online now and buy them,” says Dominique Broadway, founder of Finances Demystified.
If you’re a government worker, you can buy bonds directly by having a portion of your paycheck automatically sent to a TreasuryDirect account. You can also buy bond funds, which include multiple types of bonds, through a stock brokerage.
|Series I Bonds||Stocks|
|What it is||A loan to the government||Purchasing a share or fractional share of a company|
|What you can expect||Two interest rates: a fixed rate for the life of the loan (set twice a year), and an inflation rate that’s set twice a year||Returns can vary depending on how the market is performing|
|How much you can invest||Can purchase up to $10,000 in electronic I bonds a year, plus up to $5,000 in additional paper I bonds from cash tax refund per year||No cap on how much you can invest in per year|
|Taxes||Subject to federal income tax, not subject to state and local income tax||Profits are taxed (i.e., capital gains tax). The amount depends on your tax bracket and how long you’ve held your investments.|
|When you can sell||Three months of interest is the penalty fee if you cash out before five years||Can buy and sell at any time|
Risk vs. Guaranteed Return
It really comes down to risk versus return, says Jovan Johnson, CEO and financial advisor of Piece of Wealth Planning in Atlanta, Georgia. “Stocks are way more risky, so the opportunity for return is much higher,” he says. “That’s the trade-off you make. Series I bonds can’t give you a negative rate of return — theoretically, of course, you’re bound to at least get some kind of return. So it’s a very secure, safe product that guarantees you keep up with inflation.”
Series I bonds can be a smart addition to a diversified portfolio.
But while the bonds are set up to work with inflation, you could reap greater rewards from the stock market, which historically has returned higher than even this particularly high rate for a government bond.
Current Interest Rates for Bonds Series I
The 7.12% rate makes the Series I bond an attractive place to stash savings if you won’t need it for at least a year. This composite rate is made of a fixed rate, which remains for the life of the bond, and an inflation rate, which changes twice a year. The interest is compounded every six months, and it racks up until it hits the 30-year mark, or until you cash it out.
Let’s say you purchase $10,000 this year with the combined interest rate of 7.12%. While the inflation rate on the bond changes every six months, if the expected interest rate is at 7%, and you invest $10,000 once a year for 25 years, and your federal income tax rate is 22%, you’ll have close to $593,000 after taxes. If the expected interest is 5%, and you purchase the same amount of bonds for 25 years, you’ll have nearly $456,000.
Series I bonds stack up well against squirreling your money in a savings account that earns a measly average return of 0.06%. “This could be a good place for your emergency fund,” says Broadway. “Especially if you’re not foreseeing any major emergencies.” Note that you’ll need to hold on to your bonds for at least 12 months, and if you cash out before your bonds hit the three-year date they were issued, you’ll lose three months’ worth of interest.
Should You Invest in the Stock Market or Buy Series I Bonds?
For most people, the best strategy is to invest in both stocks and bonds.
While I bonds can be a safe place to store money that might otherwise be sitting in a low-interest savings account, they’re not really a game-changer compared to investing in stocks, especially since there’s a $10,000 cap as to how much you can purchase of I bonds in a given year, says Johnson.
Ultimately, you want to diversify your portfolio among safer investments like bonds and more aggressive investments like stocks.
If you’re at least 10 years out from when you need that money, it might be safe to have the majority of your portfolio allocation be in stocks, says Johnson. But if your timeline for withdrawing the money is under 10 years, you’ll need that portfolio to look very balanced. “At least it needs to have a percentage of bonds,” says Johnson.
The exact mix depends on your age, where you’re at in your life, and your tolerance for risk, explains Broadway. “If you’re in your 20s or 30s, maybe 5% or 10% of your overall portfolio is just bonds,” she says. “Seven percent can be great, but if you’re younger and you can handle some of the ebbs and flows in the market, you could potentially be missing out on much higher return.”
Last, you’ll want to keep in mind your retirement goals and what kind of lifestyle you would like to have during that time. “From there we can determine what is a necessary range of return that you need,” says Johnson. “That way we don’t overly risk ourselves for no reason.”