Hey everybody, we are going to talk about I-bonds today. They're formally known as Series I savings bonds. They're known as I-bonds for short, and these are the inflation-adjusted savings bonds issued by the U.S. government.
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Again, fool.com slash frankel. and be sure to click subscribe to my channel if you don't already. So a couple years ago, I-bonds were in the headlines pretty often, and it's not hard to see why.
When inflation spiked to a 40-year high in 2022, I-bonds were paying a guaranteed yield of over 9.6%, guaranteed from the U.S. government. So not surprising that a lot of people put money into them at that point. a lot of people had interest in i bonds at that point the yields have come down significantly um they're about a little less than one-third of what they were in 2022 but i think they could still be a good idea for not all but for some of your investment dollars some of your fixed income portion of your portfolio and i want to go through the current state of i bonds how much they're paying now what that interest rate means how long it's going to last and other things you need to know and why I think you should still consider putting some money into I-bonds in 2024 as we go into 2025. So let me share my screen real quick.
So just take one second. And here we go. So as I mentioned, the rates have dropped considerably. The interest rate on Series I savings bonds or I-bonds has dropped to 3.11%. That's down from 4.28%.
Just just recently, 5.27% before that, and 9.62%, which was the all-time high in 2022. So this new rate of 3.11%, that applies to I-bonds that are issued from November, so now, through April of 2025. I-bond rates are adjusted every six months, and you're guaranteed a certain rate for six months, and every six months thereafter, it will reset to the current rate. It doesn't reset the second that the new rate is announced. It's every six-month anniversary that the rate will reset. So if you buy a bond in December, five months from the time you buy it, so in May, your rate would reset to whatever they announce next April. So that 3.11% rate is guaranteed for six months.
We don't know what's going to happen beyond that is kind of the point of that. So there are two components to an I-bonds interest rate. 3.11% can be broken up into two categories. Some of it is a fixed interest rate that will stay the same for the entire life of the bond. So if your fixed interest rate is 1%, no matter what happens in the future, no matter what inflation is, that is the fixed rate that your bond will have.
Number two is an inflation adjustment, and that applies to all outstanding I bonds for that six-month period of time. So Just for a basic example, if a bond's fixed rate is 1% and the inflation adjustment is 3%, your total yield would be about 4%. I say about because there's some compounding math that goes on there.
I don't want to turn this into a math lesson, but pretty much you add the fixed component and the inflation adjustment and you get your overall I bond interest rate. So for the ones that were announced today, that 3.11 rate can be broken down as follows. There is a fixed rate of 1.2% that will apply the entire time you own this I-bond. It can be five years, 10 years, 20 years. That rate will not change.
There is a variable component of 1.9% right now. So for everyone who bought I-bonds in the past, that 1.9% will be added to whatever their fixed rate is. They might not have a 3.11% rate. Theirs might be something different.
For a while there, there was a fixed rate of 0%. Um, so some I bonds are only paying 1.9% right now. So that fixed rate really makes a difference. Um, now if you notice those don't add up to exactly 3.11%, I mentioned there's some, you know, some math and rounding that goes on.
Um, but those are the two components right now that you need to know. And the good news is that other than the 1.3% fixed rate that applied to I bonds sold in May through October of this year. That 1.2% fixed rate is the highest applied to IBONs since 2007. Generally, it's in the 0 to 0.5 range. And if inflation spikes and we see very high inflation adjustments again, this could make locking in IBONs now a very good idea. So just to kind of talk about that all-time high that we saw in 2022. So in mid-2022, IBONs had a 0% fixed rate, but they had a 9.62% inflation adjustment.
So if you had owned an I-bond previously that had a 1.2% fixed rate with that adjustment, you could add those two together and you could expect to get a yield of about 10.82%. So significantly more because of that fixed rate component. So right now is a pretty low inflation time. Inflation's come down to almost where the 2% that the Fed wants to see. If you look at the I-bond inflation adjustment, it's not even 2%.
So... It's not a big inflationary environment right now. So now could be a good time to add these to your portfolio or your investment strategy while that fixed rate component is 1.2%, which is historically high for an I bond. So just a couple of things to know, some of these potential drawbacks and just kind of rules you need to know right now, full disclosure, you can get a better yield than 3.1% from a high yield savings account or from a CD.
and you have more investment flexibility. A high-yield savings account, of course, you can withdraw whenever you want to. It's really easy. And my high-yield savings account pays 4.2% right now.
I bonds tend to work best in an inflation environment, but they don't work best in a high-rate environment. Those are two different things. Right now, we're in a relatively high-rate environment, meaning that the federal funds rate is still relatively high, mortgage rates are relatively high. Treasury yields are relatively high, et cetera.
But it's not an inflationary environment, so I-bonds are paying less than those other instruments. So over time, that can change. But for now, you can easily get a better yield somewhere else. Not saying you should, but you can. One potential drawback is there's a $10,000 per person annual maximum that you can buy of I-bonds.
You can potentially buy an extra $5,000 if you use a tax refund. But these are capped. You can't put an unlimited amount of money into these.
And a kind of drawback you should know about when it comes to flexibility is I-bonds cannot be cashed out at all for one year, regardless of whether you're willing to pay a penalty or not. And you will pay a penalty. It's, I think, a year's worth of interest if you cash it out before five years have passed. So these are meant as kind of long-term inflation hedges. not just kind of quick plays on inflation to get a 9% yield when inflation spikes and then you cash out, put the money back into the stock market.
Not really. It doesn't work that way. These are more long-term inflation hedges, but depending on when you lock that fixed rate in, they could be great inflation hedges. And if you have some extra cash for a fixed income allocation right now, it might not be a bad idea, especially if you're relatively young and have time to let these I-buns just kind of sit in your portfolio.
Now could be a good time to lock that good fixed rate in. And if inflation spikes, you'll be really glad you did. I'd love to answer any questions you have.
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