Series I Bonds Explained

With inflation topping multi-decade records, it’s no wonder investors are looking for answers. Retired folks may be especially concerned. After all, stubborn inflation makes it harder for them to stretch their retirement income. This article will take a closer look at Series I bonds and why you might want to consider them.

Often, investors have turned to gold as an investment to fight high inflation. Some professional investors question gold’s merits as an investment. It does not produce income, and people do not use the metal for anything other than jewelry. For instance, most of the world’s gold sits in bank vaults.

There has been a correlation between inflation and gold prices in the past. If you’re skeptical that correlation can persist, you may consider Series I bonds.

Benefits of investing in Series I bonds.

What are Series I Bonds?

Series I bonds are issued by the U.S. Treasury Department. They pay a fixed interest rate plus a variable rate of interest. The Treasury determines the fixed-rate, and the  Consumer Price Index (CPI) determines the variable rate. The CPI measures how much a basket of commonly purchased goods and services changes over time.

With the surge in inflation over the last several months, the rate on Series I bonds has jumped. Currently, they have a rate of 7.12%. Keep in mind that the rate on them resets at the end of April.

March inflation data determines the variable rate for May. Inflation was 8.5%, the highest since the early 1980s. So, investors in Series I bonds could see their rate increase again.

In addition, Series I bonds are low risk. Because the U.S. Treasury issues the bonds, the bonds are backed by the full faith and credit of the U.S. government. Like other treasury-issued bonds, investors consider them to be among the safest in the world.

Though Series I bonds are issued by the Treasury, they’re different from other Treasury notes and bonds in several ways. Make sure you fully understand the ins and outs of Series I bonds before investing. Let’s take a closer look.

How to Buy Series I Bonds

The first thing you need to know about how to buy Series I Bonds is that you can only buy the bonds through the Treasury website. You cannot buy them through your regular brokerage account. Though you would not be able to use your brokerage account, the Treasury does not charge fees for the transaction.

Also, Series I Bonds come in smaller denominations than typical bonds (here’s a free traditional bond yield calculator). Investors can buy them for as little as $50, $100, $200, $500 or $1,000 each. A single investor can purchase up to a maximum of $10,000 each year. Additionally, you could also buy $10,000 for your spouse or children.

If you buy Series I Bonds with your tax refund, you’re eligible for an extra allotment. This allotment is in addition to the regular $10,000 maximum. You can buy up to $5,000 of them if you go this route.

The maximum limit will affect everyone differently. For instance, high-net-worth investors may pass on Series I Bonds because the $10,000 max limit wouldn’t be enough to make a difference in their portfolio. On the other hand, if an allocation of Series I Bonds is a meaningful portion of your portfolio, you could benefit handsomely.

Series I Bonds Interest Rates

The variable part of Series I Bond interest rates resets every six months. If you think inflation will persist for the rest of the year, these may be appealing. On the other hand, if inflation returns to normal levels, the variable part of the interest rate may decrease.

You cannot sell Series I Bonds on a secondary market. You must redeem them with the Treasury if you want to get rid of them. In addition, they have a minimum one-year holding period. Future inflation is an important consideration.

You’ll be subject to early redemption penalties if you decide to redeem your bonds in less than five years. The early redemption penalty requires you to forfeit three months of interest. After five years, there is no penalty.

In some cases, paying the early redemption penalty may not be that bad. Interest paid on bank deposits, CDs and treasury bonds are historically low. The interest you earn from Series I Bonds for one year may be a better option, even if you pay the early redemption penalty.

Readers should also note that they are good for 30 years. So, if you believe that inflation is here to stay, these could be an excellent investment for you. Although, if inflation returns to normal levels soon, the early redemption penalty may be painful.

Final Thoughts

The U.S. Treasury will announce new rates on May 2. There is much to consider if you’re interested in Series I Bonds. One of those considerations is taxes.

Interest from them is exempt from state taxes but is taxable for Federal taxes. If the bondholder uses the interest to fund education, it could be excluded from federal taxes. Please consult your tax advisor before making any decisions.

The post Series I Bonds Explained appeared first on Investment U.

Are Fixed-Rate Bonds a Good Investment?

Fixed-rate bonds have been a popular investment tool for centuries. Investors make an investment in a fixed-rate bond by lending money to the issuer for a specified time. At the end of the specified time (maturity), the issuer returns the investor’s money. In the meantime, the issuer pays the investor interest based on a fixed rate. Interest payments are typically semi-annual but can be annual, monthly or even weekly.

Different types of entities can issue bonds. These entities are looking to raise capital by borrowing money (principal) from investors. Bond issuers are mostly corporations or governments. A corporation may want to borrow money to run its business or pay for a project. In addition, a government may issue bonds to raise money for public services or to meet budget shortfalls.

For each bond an entity issues, it publishes an indenture. A bond indenture spells out the legal disclosures of the bond, including maturity, fixed interest rate (coupon), date of coupon payments, and certain covenants. Covenants place limits on the issuer to ensure the issuer can pay interest and principal at maturity. Fixed-rate bond investors like them because they’ve historically been a lower-risk option compared to stocks and other investments.

Investing in fixed-rate bonds.

Why Invest in Fixed-Rate Bonds

There are many reasons why investors like fixed-rate bonds. One reason is that bond investors view bonds as a safe investment. By issuing an indenture, the borrower commits to making interest and principal payments to investors. The interest and principal payments come from the profits of a corporation, taxes received by governments or revenue from specific government services.

Asset-backed bonds are like folks borrowing money against their home. A corporation can pledge assets to back the bond in some instances. For example, a corporation may borrow money and pledge real estate or other property as collateral. If the corporation cannot pay interest or principal, the investors can claim the asset, sell it and get some or all the money the borrower owes them.

Another reason that investors like fixed-rate bonds is diversification. Bonds do not change in price as much as stocks or other investments. Wild swings in the stock market can cause investors to lose sleep. By investing in a portfolio of bonds, investors may feel better that their portfolio will be more stable over time. Many investors also chose to invest part of their portfolios in bonds and in stocks.

Risks

Though investors believe bonds to be safer than stocks, there are no guarantees. For instance, a corporation may go bankrupt or choose not to pay interest or principal. These are extreme cases, but they do happen.

If a bond issuer cannot make payments, the risk investors take called default risk. If a bond issuer goes bankrupt, it will sell all its assets and pay all its debts, like bonds. Asset-backed bondholders may get their principal and any interest due from the asset’s sale. Bonds not backed by assets will get the money left over from asset sales. Stockholders are last in line for money raised by asset sales.

Bond prices have historically swung less than stocks. Though, bond prices do change. When overall interest rates change, bond prices for fixed-rate bonds also change. For instance, say you hold a bond with a 5% coupon, and interest rates drop to 4% for new bonds with the same maturity. If you want to sell your bond, you can get a higher price because a seller can either buy the new 4% bond or buy yours for a higher price so that the yield to maturity is 4%. If you hold the bond to maturity, price changes are of little concern because you’ll receive your principal at maturity regardless of the price changes.

Fixed-Rate Bond Mutual Funds and ETFs

If you’re not interested in reading through indentures, disclosures or trading bonds, you’re in luck. Fixed-Rate Bond mutual funds pool investors’ money, and a fund manager invests money in the mutual fund for you. Interest payments for the bonds held in the mutual fund are paid to investors by the fund. Each mutual fund will charge a fee for its services.

Fixed-rate bond ETFs are a bit different. You own a basket of bonds through the ETFs structure instead of a portion of the pooled assets like a mutual fund. ETFs also have managers who invest your money in bonds. The ETF manager pays you the interest on each bond and charges a fee for their services. Though, fees are typically lower than mutual funds.

Bond mutual funds and ETFs can focus on certain types of bonds. For instance, they can hold only treasurycorporate or municipal bonds. Some can focus on short-term maturity bonds, which typically pay a lower coupon but may be safer. Managers can also invest in high-yield (junk) bonds that pay a higher coupon but have higher default risk.

The post Are Fixed-Rate Bonds a Good Investment? appeared first on Investment U.

Treasury Direct Bonds

What ultra-safe investment is currently paying a high interest rate? The answer is certain Treasury Direct bonds.  For instance, inflation-indexed Series I bonds issued from November 2021 to April 2022 are paying 7.12 percent for the first six months. Interest is a combination of a fixed rate and an inflation rate. While the fixed rate is annual, the inflation rate may change every six months. If the inflation rate remains high, so will the yield. Compare that with the extremely low rates offered on other safe investments such as certificates of deposit and savings accounts. For that reason, the sale of Series I bonds is booming.

Treasury direct bonds explained.

What are Treasury Direct Bonds?

Treasury bonds are government debt securities. Issued by the federal government, they are sold by the U.S. Treasury Department. Interest on treasury bonds is exempt from state and local taxes.

These bonds are sold on TreasuryDirect.gov which is managed by the Bureau of Fiscal Service.  Because the U.S. government issues Treasury Direct bonds, they are risk-free.

Treasury bonds, issued for terms of 20 or 30 years, pay interest every six months until maturity. At maturity, bond owners receive the face value. Note that once bonds mature, they no longer pay interest. Prices and yields of treasury bonds are determined at auction.

The series EE bonds, long a college savings favorite, earn a fixed rate of interest. These bonds are guaranteed to double in 20 years. In contrast, there is no guarantee that an I bond will grow to a specified amount.

In the past, Treasury bonds were issued in paper form. Now, Treasury bonds are all issued electronically.

How to Buy Treasury Direct Bonds

Purchase Treasury Direct bonds via TreasuryDirect.gov or from banks or brokers. Before buying bonds, you must set up an account. A personal checking or savings account is necessary to pay for bonds through TreasuryDirect. Such an account is also required to accept funds upon bond redemption.

As the New York Times notes, the TreasuryDirect website needs updating. While users submit bank information when signing up, changing that bank account later requires the use of a paper form. To make the change, users must print out a form and take it to their bank or credit union for bank officer certification. It is then mailed to a U.S. Treasury post office address in Minneapolis. It generally takes about 10 business days after form receipt for an updating of the TreasuryDirect account.

While TreasuryDirect representatives say that a modernization is underway that will permit users to change bank accounts without resorting to paper forms, no timetable was given. For now, if you want to set up an account to buy Treasury Direct bonds, choose a checking or savings account you plan to keep for a long time to avoid this hassle.

Buy Treasury Direct Bonds With Your Tax Refund

Expecting a federal or state tax refund? You can have that amount directed to your TreasuryDirect account by requesting the IRS or your state tax department to deposit your refund there. Purchase savings bonds once you receive the funds.

On your tax return, simply add the TreasuryDirect routing number, 051736158, in the routing number field. In the account number field, add your TreasuryDirect account number. For “account type,” choose Savings.

Competitive vs. Non-competitive Bids

Two types of bids are used at Treasury bond auctions. With non-competitive bids, the purchaser agrees to the interest rate determined at auction. The buyer receives the bonds they want at the full amount desired. Virtually all individual investors go the non-competitive route.

With competitive bids, the buyer specifies an acceptable yield. The result is:

  • Acceptance of the full amount if the bid is less than or equal to the yield determined at auction.
  • Acceptance of less than the full amount if the bid is equal to the high yield.
  • Rejection if the specified yield exceeds that of the yield set at auction.

You cannot use competitive bidding through TreasuryDirect.gov. Instead, bidders must use a bank or broker. The majority of competitive bidders are institutional investors.

Minimum and Maximum Purchase Amounts

The minimum amount needed for purchasing Treasury Direct bonds is just $100. Bond amounts rise in increments of $100.

The maximum noncompetitive purchase amount in a single auction is $5 million. For a competitive bid, it is 35 percent of the offering amount.

Treasury Direct Bonds Considerations

You won’t receive 1099 forms or statements from your TreasuryDirect account. You can view the 1099 online and print it. Make sure your spouse and heirs are aware of this account. If you die and don’t leave information about the account, the executor of your estate may never discover it. That’s because most executors use tax returns or financial statements for information about the decedent’s accounts, and TreasuryDirect won’t show up there.

There are a few items to keep in mind when purchasing Treasury Direct bonds. For example, while buyers don’t have to hold an I bond for 30 years, they do have to hold it for one year before redemption. Holding the bond for more than one year but less than five years triggers a three months’ interest penalty. Bonds held for more than five years are not subject to this penalty.

The post Treasury Direct Bonds appeared first on Investment U.