Are I Bonds a Good Investment? Pros and Cons

I Bonds, or Series I savings bonds, are government-backed securities designed to help protect your money from inflation. These bonds combine a fixed interest rate with an inflation-adjusted rate, making them attractive during periods of rising prices. While they offer a safe way to earn interest and preserve purchasing power, I Bonds come with limitations, including annual purchase caps and early withdrawal penalties.

A financial advisor can help assess whether and when I Bonds might align with your broader investment goals..

What Are I Bonds?

I Bonds are a type of U.S. savings bond specifically designed to protect your money from the effects of inflation. They are issued by the U.S. Treasury and have a unique structure: Each I Bond earns interest through a combination of a fixed rate and an inflation rate. The fixed rate remains the same throughout the duration of the bond, while the inflation rate is adjusted every six months to reflect changes in the Consumer Price Index (CPI).

Interest earned on an I Bond is added to its value every six months. As a result, the bond grows in value over time, offering both inflation protection and compounded interest.

Although I Bonds mature in 30 years, they can be redeemed after one year. However, if you redeem an I Bond within the first five years, you lose the last three months of earned interest as a penalty.

Are I Bonds a Good Investment?

I Bonds come with advantages and disadvantages, which makes them suitable for certain types of investors but not ideal for everyone. Here are the pros and cons of I Bonds to help you decide how they could fit your investment strategy:

Pros of I Bonds

Inflation protection: The interest rate of I Bonds is tied to inflation, which means your investment is safeguarded against the eroding effects of rising prices. This feature becomes more relevant during periods of elevated inflation, helping your money retain its purchasing power.
Safety and security: Since I Bonds are issued by the U.S. Treasury, they are backed by the full faith and credit of the U.S. government. This makes them one of the safest investments available, with little risk of default.
Tax benefits: The interest earned on I Bonds is exempt from state and local income taxes. Additionally, federal taxes can be deferred until you cash in the bond. If the funds are used for qualifying educational expenses, you may even be able to avoid federal taxes on the interest.
Guaranteed returns: The fixed rate portion of the I Bond provides a guaranteed base return, which, while modest, adds a layer of predictability to your overall earnings.
Flexible redemption options: While I Bonds have a 30-year maturity period, they can be cashed out anytime after 12 months. This offers some flexibility if you need access to your money. However, early withdrawal may result in penalties.

Cons of I Bonds

Purchase limits: Investors are limited to purchasing a maximum of $10,000 in electronic I Bonds per year, with an additional $5,000 available in paper I Bonds if purchased using tax refunds. This cap makes I Bonds unsuitable for those looking to invest larger sums.
Early withdrawal penalty: If you cash in your I Bonds before five years have passed, you lose the last three months of earned interest. This penalty may impact liquidity for those who need their funds sooner.
Modest returns: While I Bonds are secure, their fixed rate portion tends to be relatively low compared to other investment options. If inflation falls, the inflation-adjusted portion can shrink, further limiting returns.
Lack of market liquidity: Unlike other bonds or investments that can be traded on the secondary market, I Bonds are non-transferable. You cannot sell them to other investors, which limits flexibility compared to market-traded securities.
Long maturity period: Although I Bonds can be redeemed after one year, their full maturity period is 30 years. This extended timeframe may not align with the goals of investors seeking shorter-term opportunities.

Why Invest in I Bonds?

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Investors should consider I Bonds if they are looking for a low-risk way to protect their savings from inflation. I Bonds can be particularly attractive to conservative investors who value safety and the security of government backing.

They may also be a good choice for those who are seeking tax-advantaged growth, particularly when the proceeds are used for qualified education expenses. Further, I Bonds can serve as a useful diversification tool in an investment portfolio, providing stability during uncertain economic times.

However, I Bonds are not suitable for those seeking high returns or who need significant liquidity, as the I Bonds’ purchase limits and early withdrawal penalties can be restrictive. Evaluating your financial goals and risk tolerance will help determine if I Bonds are a suitable addition to your investment strategy.

How to Buy I Bonds

You can buy I Bonds directly through TreasuryDirect, the U.S. Treasury’s online platform. To get started, you need to create an account on TreasuryDirect.gov.

Once your account is set up, you can purchase electronic I Bonds for as little as $25, up to the annual limit of $10,000 per individual. You can also buy up to $5,000 in paper I Bonds using your federal tax refund. You can buy I Bonds at any time, with rates updated every six months.

After purchasing, you can view and manage your bonds directly through your TreasuryDirect account, making it a straightforward and accessible process for most investors.

How to Add I Bonds to Your Portfolio

A conservative investor may focus on protecting their money instead of chasing high returns. I Bonds help with this by offering a stable, low-risk way to keep up with inflation.

Because I Bonds don’t lose value and earn interest that adjusts for inflation, they can be a good fit for a safe portfolio. This investor might buy $10,000 in I Bonds each year to go along with savings accounts or Treasury bills.

Example 1: Conservative Investor Using I Bonds for Inflation Protection

A 60-year-old retiree has a $500,000 portfolio and wants to preserve purchasing power without taking on much risk. Their goal is to generate stable, inflation-protected income while minimizing exposure to market volatility. They allocate 40% of their portfolio to bonds and decide to include I Bonds within that segment.

They purchase $10,000 in I Bonds annually for five years, building a $50,000 I Bond position. These bonds serve as a long-term, low-risk component of their bond allocation, providing interest that adjusts for inflation and deferring taxes until redemption. The investor avoids early withdrawal penalties by holding the bonds past five years and uses other liquid assets for short-term needs. The I Bonds help protect against rising costs while keeping risk low.

Example 2: Growth-Oriented Investor Avoiding I Bonds Due to Return Limits

A 35-year-old investor is building wealth for long-term goals, such as early retirement. Their $200,000 portfolio is heavily weighted toward equities, with an 80/20 split between stocks and bonds. They evaluate I Bonds but decide against using them, citing the $10,000 annual purchase limit, early withdrawal penalties, and capped upside compared to equities or high-yield bond funds.

Instead, they allocate the bond portion of their portfolio to intermediate-term bond ETFs and dividend-focused mutual funds, seeking higher yield and flexibility. They accept more volatility in exchange for greater return potential. While they monitor inflation risk, they prefer assets with more growth and liquidity to support their aggressive investment timeline.

Alternatives to I Bonds

If I Bonds don’t align with your financial goals, there are several other investment options that may be worth considering. Here are eight common alternatives:

Treasury Inflation-Protected Securities (TIPS): Like I Bonds, TIPS offer protection against inflation. Their principal value adjusts with inflation, providing a hedge against rising prices.
High-yield savings accounts: These accounts provide a safe place to store cash while earning interest, offering better liquidity compared to I Bonds.
Certificates of deposit (CDs): CDs offer fixed returns over a set period, often offering the best rates on longer-term deposits. They tend to be FDIC-insured, which provides a level of security similar to that of I Bonds.
Municipal bonds: These bonds provide federal tax-exempt income and are generally safe, though they may carry slightly more risk compared to I Bonds.
Corporate bonds: For investors seeking higher returns, corporate bonds can offer better yields. However, they come with higher risk compared to government-backed options.
Bond ETFs: Exchange-traded funds (ETFs) that focus on bonds can provide diversification and liquidity, making them a flexible alternative to holding individual bonds.
Series EE Bonds: Another type of U.S. savings bond, EE Bonds offer a guaranteed doubling of value if held for 20 years, providing a predictable return.
Money market funds: These funds invest in short-term, high-quality investments, providing liquidity and a moderate level of return while maintaining a low risk profile.

Can I Lose Money Investing in I Bonds?

I Bonds are structured to avoid loss of principal, even in deflationary periods. Their value never drops below the amount you paid, and interest compounds semiannually.

However, the real return—after accounting for inflation and potential penalties—can be negative. If you redeem I Bonds within five years, you forfeit three months of interest. Additionally, during periods when inflation falls sharply, the inflation-adjusted rate can be zero or even negative, meaning the only yield comes from the fixed rate—which can be low.

While you won’t lose your initial investment, the opportunity cost compared to other assets could be meaningful.

Bottom Line

I Bonds offer a secure way to protect savings from inflation while earning a modest return. They may be particularly appealing to those seeking safety and government backing, as well as tax advantages. However, purchase limits, early withdrawal penalties and a long maturity period may make them less attractive to some. By considering alternatives like TIPS, CDs or bond ETFs, you can find an option that suits your individual needs, risk tolerance and financial goals.

Invest Planning Tips

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