Investigating I Bonds

Not many corners of the fixed income market are drawing rave reviews in 2022. That’s understandable as the widely followed Bloomberg US Aggregate Bond Index is down 9.13% year-to-date.

Among the fixed income assets that are proving durable/less bad are, not surprisingly, those with positive correlations to inflations. However, that conversation doesn’t begin and end with Treasury Inflation-Protected Securities (TIPS). Thanks to I bonds, also known as I savings bonds, advisors have another option to add to the inflation-fighting toolbox.

I bonds differ from other fixed income assets in that they must be purchased directly from the Treasury – no exchange traded funds or mutual funds here as of yet – but there are perks that make these bonds enticing for clients. For advisors, I bonds represent an avenue to show value to income-hungry, risk-averse clients and a way into educational conversations with other clients.

“I Bonds can be purchased through October 2022 at the current rate.  That rate is applied to the 6 months after the purchase is made.  For example, if you buy an I bond on July 1, 2022, the 9.62% would be applied through December 31, 2022.  Interest is compounded semi-annually,” according to TreasuryDirect.

I Bond Benefits

While I bonds aren’t accessible in fund form and maximum purchase allowed per tax identification number is $10,000 per year, the asset class offers benefits.

For example, clients are liable for state and local taxes on I bond interest. Additionally, these bonds come with the benefit of a fixed rate that never changes over the life of the bond and a inflation-based rate that’s adjusted twice per year.

“I bonds earn interest for 30 years unless you cash them first. You can cash them after one year. But if you cash them before five years, you lose the previous three months of interest. (For example, if you cash an I bond after 18 months, you get the first 15 months of interest.),” adds TreasuryDirect.

Another element in the I bond conversation that advisors can mention to clients, with the caveat that past performance doesn’t guarantee future returns, is the long-term track record of I bonds. Dating back to 1998, which marks the debut of these bonds, the asset class impresses against other fixed income assets, including an I bond without fixed rates and baskets of short-term Treasuries and T-bills,

“The actual I Bond, with its 3.4% bonus, crushed the investment alternatives. However, returns from the remaining three rivals were close. Treasury notes led the way, followed by the zero fixed-rate I Bond, with Treasury bills occupying the rear. However, as I Bonds were less volatile, even the stripped-down I Bond was best investment of the three, as measured by risk/reward,” notes Morningstar’s John Rekenthaler.

And yes, I bonds have been beating TIPS for close to two decades. That’s another point in favor of the asset class and one that makes it easier for advisors to start the I bonds conversation.

Not Perfect, But Nothing Is

As noted above, I bonds have myriad advantages, but they aren’t perfect.

“It is true that I Bonds possess several disadvantages. They cannot be bought in high quantities or held within brokerage accounts,” concludes Rekenthaler. “Nor can they be traded. However, even without their now-departed fixed-rate payments, they merit serious consideration for strategic portfolios. Even when inflation has been dormant, as during most of the past 24 years, they have held their own against Treasury notes, bills, and TIPS. And should today’s higher inflation rates not subside, their relative performance will be stronger yet.”

The point: Clients still need income and protection from equity market volatility. I bonds deserve further consideration, particularly as more popular fixed income segments wither against the backdrop of rising interest rates.