Investments come in all shapes and sizes. As investors we often look at return rates—how quickly can your investment grow—and risks involved. Risks come in many flavors. Some investments guarantee that you will never lose your principal. Others can drain your principal to zero or even demand cash calls to keep the investment alive. Typically return rates and risk are inversely proportional, and it is up to the investor to decide how much risk and return she can stomach.
When we think of interest rates and compound interest, zero percentage interest sounds lousy. It basically means that your principal isn’t growing. We only like hearing zero percent interest when financing cars or when vendors entice customers to make a purchase. However, the atrocious interest rates in fixed securities in 2020 and 2021 have brought more light to something I’ve kept in my financial plan for quite some time.
The U.S. Treasury and I-Bonds
The United States government sells securities in various forms that average people like you or me can buy. These are considered some of the most stable investments since they are backed by the government—this means that the government would have to collapse in order for something bad to happen to your investment. One of these securities is called an Individual Bond, or I-Bond. Bonds in general are not sexy—you generally have to hold them for thirty years, and the interest rates are abysmal. Furthermore, you can only buy up to $10,000 worth of I-Bonds per year directly. I’ve been purchasing I-Bonds for the past several years as a way to park some money.
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I-Bonds offer an interest rate formed from combining the current inflation rate and a fixed rate. The fixed interest rate has been 0%, and will remain at 0% until April 2021. The interesting thing is that the inflation rate is currently 1.68%. That means you can achieve an interest rate of 1.68% on I-Bonds! That is significantly better than any other fixed security like T-bill or CD that a bank would offer. And your money’s value isn’t getting eroded by inflation.
Using the I-Bond as a short-term security
I give full credit to Harry Sit of The Finance Buff for this tidbit. My intention to purchase I-Bonds has always been to park money in a stable vehicle for the long term. The investment amount per person is capped at $10,000 per year, so we aren’t enticed to put our entire earnings in I-Bonds. The penalty for early withdrawal is 3 months of interest, which isn’t much anyway given the low interest rates in this vehicle as well.
Harry brought up the idea to use I-Bonds sort of as an emergency fund. The penalty for early withdrawal is not atrocious, and the principal amount isn’t eroding away in some money market account earning 0.45% interest and taxed at your marginal rate. Smart move.
So the bottom line is that despite having a zero percent fixed rate, I-Bond isn’t a horrible means to park your funds. I’ll still continue to purchase I-Bonds every year, but if I am in need of emergency funds, I would not hesitate to make an early withdrawal.
You can head over to the Treasury Direct website, and open an account. As a recap, here is a table of facts for the I-Bond:
|Interest Rate||Inflation+Fixed = 1.68% as of Jan 2021|
|Early withdrawal penalty||3 months interest|
|Earliest withdrawal||roughly 1 year|
|Holding period||30 years|
|Maximum amount per year||$10,000|
|Tax rate||Federal marginal rate; State tax free|
Will you see I-Bonds in new light now? (Photo courtesy of the US Treasury Website)